Money Psychology 4: Confounding compounding
Good investing is about earning good returns, which you can stick with and can repeat for the longest period. If a little growth serves as the fuel for future growth, a small starting base can lead to results so extraordinary that they seem to defy logic.
Let’s take the example of the Ice Age.
Evidence suggests Earth didn’t have only one Ice Age, but five (which we could measure). But no theory could explain the formation of the Ice Age and the cyclical repetition.
In the early 1900s, a Serbian scientist Milutin Milanković studied the Earth's position relative to other planets. He came up with a theory which seems accurate.
The gravitational pull of the sun and moon gently affect the Earth’s motion and tilt toward the sun. During parts of this cycle, which can last tens of thousands of years, each of the Earth's hemispheres gets a little more, or a little less, solar radiation than they're used to.
A Russian meteorologist Wladimir Köppen dug deeper into Milanković's work and discovered how the cycle begins.
It begins when a summer never gets warm enough to melt previous winter's snow. The leftover ice base makes it easier for snow to accumulate the following winter, which increases the odds of snow sticking around in the following summer, which attracts even more accumulation the following winter.
The same thing happens in reverse. An orbital tilt, letting more sunlight in, melts more of the winter snowpack, which reflects less light the following years, which increases temperatures, which prevents more snow the next year, and so on. That's the cycle.
Yes, you don't need tremendous force to create tremendous results.
More than 2,000 books are dedicated to how Warren Buffett built his fortune. Many of them are wonderful. But few pay enough attention to the simplest fact: Buffett's fortune isn't due to just being a good investor, but being a good investor since he was literally a child.
His skill is investing, but his secret is time. He’s been a phenomenal investor for three quarters of a century.
Our minds are not built to handle such absurdities.
[The Psychology of Money: Lessons 4 of 18]
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