Last Man Standing

Amazon in 2014 was a puzzle. It was big. It was growing. It had market share and mindshare. Competitors feared it as much as customers loved it.

What it didn’t have was a good business.

Profit margins wobbled between negligible and negative. That might be acceptable for a young startup, but Amazon was two decades old at the time. The whole thing was easy to mock and call a bubble.

Jeff Bezos had a different view: Margins don’t matter. Dollars do. A huge business with low margins was preferable to the opposite. He explained in 2014:

Margins are not one of the things we are seeking to optimize. It’s the absolute dollar free cash flow per share that you want to maximize.

Free cash flow [is] something that investors can spend. Investors can’t spend percentage margins … What matters always is dollar margins: the actual dollar amount. Companies are valued not on their margins, but on how many dollars they actually make.

There are parts to quibble with here, but I just liked Bezos’s simple logic: The business with the most dollars wins. Not the best margins or the highest quarterly growth. Just how many dollars you generate over the long run.

Let me propose the equivalent for individual investors. It might push you away trying to earn the highest returns because returns, like margins, don’t matter; generating wealth does.

Everything worthwhile in investing comes from compounding. Compounding is the whole secret sauce, the rocket fuel, that creates fortunes.

And compounding is just returns leveraged with time.

Earning a 20% return in one year is neat. Doing it for three years is cool. Earning 20% per year for 30 years creates something so extraordinary it’s hard to fathom. Time is the investing factor that separates, “Hey, nice work,” from “Wait, what? Are you serious?”

The time component of compounding is why 99% of Warren Buffett’s net worth came after his 50th birthday, and 97% came after he turned 65.

Yes, he’s a good investor.

But a lot of people are good investors.

Buffett’s secret is that he’s been a good investor for 80 years. His secret is time. Most investing secrets are.

Once you accept that compounding is where the magic happens, and realize how critical time is to compounding, the most important question to answer as an investor is not, “How can I earn the highest returns?” It’s, “What are the best returns I can sustain for the longest period of time?”

That’s how you maximize wealth.

And the most important point is that the best returns you can earn for the longest period of time are rarely the highest returns in any given year, or even decade.

Charlie Munger says “the first rule of compounding is to never interrupt it unnecessarily.”

Interrupting it can happen in many ways. The most common is finding a strategy that produces high returns for a period of time then abandoning it when it inevitably has a few bad years.

Investing in a strategy or sector that produces great returns for five years but shakes your faith to the point of abandonment after a collapse in year six will likely leave you worse off than a strategy that produces merely good returns but you can stick with for years six, seven, eight, 10, 20, etc. This is especially true if, after abandoning a strategy in its down year, you move on to whatever the new hot thing is only to repeat the process.

Complexity is another door to interruption. It can produce higher returns. But the more knobs you have to fiddle with, the more levers you have to pull, the higher the odds that something, at some point, will cause you to second-guess yourself, or reveal a risk you hadn’t considered, or tempt your clients to leave – all of which stops the clock of compounding and can outweigh any return advantage you had when the strategy worked.

None of that is intuitive in the moment, because the pursuit of the best returns at all times feels like the best way to maximize wealth.

It’s not until you consider the time factor of compounding that you realize maximizing annual returns in a given year and maximizing long-term wealth are two different things.

Carl Richards once made the point that a house might be the best investment most people ever make. It’s not that housing provides great returns – it does not. It’s not even the leverage. It’s that people are more likely to buy a house and sit on it without interruption for years or decades than any other asset. It’s the one asset people give compounding a fighting chance to work.

Everyone’s different, with varying levels of confidence and tolerance for what they can put up with in investing.

But the idea that endurance is more important than annual returns even if annual returns get all the attention is something virtually every investor should think more about.

Airbnb CEO Brian Chesky once said, “If you’re trying to win in the next year, and I’m trying to win in the next five years, we both might win. But I’m ultimately going to win.”

That’s the whole idea.

Bezos’s goal isn’t to have the best business. It’s to make the most dollars.

Likewise, investors’ goals shouldn’t be the best annual returns. It should be to maximize wealth. And you get that through endurance – not to be the best in any given year, but to be the last man standing.

This kid has it all figured out: