Compounding Returns
Compounding Returns and Why It’s Easier In Private Companies.
Albert Einstein almost certainly didn’t say this but is commonly thought to have said, “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn't, pays it.”
I have spent many years running active capital in the share market. I spent way too much time 'tick watching'. It's embarrassing when I think about it. Sitting in front of the Bloomberg, watching the portfolio, looking at watch lists of individual shares for what’s moving.
The problem with having a listed share price is that it entices you to make a decision. Is that news good or bad? Should I get out? Should I get back in!? Add to that the investment community of brokers and dealers that is built around you making a decision. Fees are paid for action, not inaction. It is extraordinarily difficult to do nothing.
My friend Weimin Xie who runs MX Capital reminded me the other day that buying stocks is easy, selling them is the hard part.
The idea that everyone agrees on is that you should ride your winners and cut your losers. Easy right? What if I tell you that the share you own just went up 100% over night on some news you think is wrong. 'I will just sell a little bit, that's a silly move'. I've told myself that many times. On the really big winning idea, the problem is that you cut a little bit every time it goes up and before long you are left with a fraction of what you started with. You have killed Einstein's eighth wonder of the world! You have cut your compounding machine.
For the professional money manager it is even harder. If you start with a 5% that goes up 4 times. You probably now have a circa 20% position. Most of your clients are unhappy with the risk of such a large position so you sell some to reduce the exposure. Crazy!
Contrast this to when you invest in private companies. The price quotes come during financing events possibly yearly, but sometimes longer. And these financing events do not always come with a liquidity event. Not many decisions to make now. But when you get an option to sell, you can use your slow thinking brain as opposed to your fast thinking brain to make a better decision. Of course in private investing when things go wrong, you also can't change your mind. But we are talking about compounding returns here not risk management, position size, diversification et al.
The wonder of compounding comes more naturally in this form. You watch the business fundamental much more (because you can't stare at a price ticking on the screen). You are on the journey with the founders and management. You are part of the business, part of the team.
I have no solution for holding listed positions longer to enjoy the wonder of compounding, but looking at the different investor journey is illuminating.
