Preamble: the power of compounding
Here is a table of $10,000 invested for various time periods at various compounded real returns (real return = total return less inflation). For the long time periods you could imagine inter-generational wealth transfers where subsequent generations dutifully reinvested the capital without touching the principal:
If you really study this table, you will see how powerful compounding is and how bad human intuition is at exponential math. Human brains are innately wired to understand linear math but are bad at non-linear math. As someone who is mathematically sophisticated and works with exponents every single day professionally, I can tell you that I am still consistently surprised when I calculate compounded returns.
The Paradox of Positive Real Returns
Human Civilization is about 6,000 years old.
Caesar proclaimed himself the first Roman Emperor in 31 BC, about 2,050 years ago.
Imagine if we took one ounce of gold during the Roman Empire. As of December 31, 2020, that ounce of gold was worth about $1,800 US Dollars. If one had invested that ounce of gold during the Roman Empire 2,000 years ago and earned a 1% real return above the rate of inflation, this would be worth almost $800 Billion USD. As of the end of 2020, this would be roughly equal to the combined net worth of the top-6 wealthiest people on Earth (Bezos + Musk + Arnault + Gates + Zuckerberg + Ellison). If one’s ancestors took that modest initial investment, earned that modest 1% real return, saved it and every generation passed it to one lucky heir who faithfully did the same, that lucky heir would be by far the wealthiest person on Earth.
But, if you ask virtually any financial pundit today, a 1% annualized real return is unimpressive. What if it was a 2% annualized real return? At a 2% annualized real return, that $1,800 would be worth almost $300 Quintrillion USD (a quintrillion is a million trillion or a thousand quadrillion or a billion billion). Total global GDP is just a shade under 150 Trillion US Dollars in 2020. Now we are in the realm of mathematical impossibility. It is impossible to create that much value with the finite resources of this planet – one individual cannot amass wealth exceeding total global GDP by several orders of magnitude.
What lessons should we earn from this exercise?
Here are a couple quick and easy lessons:
- Earning a positive real return over long time periods is not trivial! It is hard!
- Never underestimate the power of compounding!
- To reiterate: compounding is unintuitive – our feeble human brains have a hard time appreciating it – it is almost like magic.
The most important lesson, I would argue is not mathematical or financial – it is historical. It is exceedingly difficult for financial and political institutions to survive for hundreds of years, let alone millennia.
It would have been impractical for anyone to successfully implement this investment plan and maintain a safe store of wealth through the tumult of the ensuing millennia as all of Rome’s financial and political institutions disintegrated and reformed many times over.
The Roman Empire was overrun by Germanic tribes. In the middle ages, Italy was variously carved up by Islamic and Byzantine powers. Later, it split up into city-states over which the Vatican exerted varying degrees of influence. During the 1800s it was unified as the Kingdom of Italy and became one of the world’s great colonial powers. In World War 2, under the influence of fascism it disastrously allied itself with Germany. Since the end of World War 2, Italy has been a mostly politically stable republican democracy, though it has also suffered many economic crises.
Therefore, the overarching and somewhat depressing lesson is Impermanence. All institutions inevitably come to an end, which is an obstacle to the wealth preservation that enables compounding at scale. In our living memory, it feels like the USA has existed forever and will continue to exist forever. But, it has been only about 250 years, and sadly whether it endures another 250 years is far from guaranteed.
In Buddhism, Impermanence is one of the Three Noble Truths (the other two noble truths are No-Self and Suffering). Nothing lasts forever, and therefore nothing can compound forever.