By
Tom Dyson, publisher, The Palm Beach Letter
Monday, August 24, 2009
Today, I'm going to tell you about an investment I call a "Compound Interest Club."
Compounding your interest is the only mathematically certain way of making money from your investments. Einstein supposedly called this technique the most powerful force in the universe. I've written about "compounding interest" in DailyWealth before. It'll be the first financial lesson I teach my children.
Suppose a bank account pays 15% annual interest. You deposit $100 in the account. At the end of the year, the bank pays you $15 in interest. To harness the power of compounding, all you have to do is leave the $15 in the account. This way, the $15 interest payment begins earning interest, too. During the second year, you'll earn $17.25 in interest instead of $15.
The extra $2.25 may not sound like much, but when you magnify this effect over many years, huge numbers result. Take the 15% bank account as an example. One hundred dollars turns into $6,621 over 30 years... a gain of 6,521%.
Compound Interest Clubs, as the name suggests, are vehicles for compounding your money. Depending on their quality, they will compound your money anywhere from 10% to 25% a year on average... and they'll keep compounding whether we're in a recession, a depression, a boom, inflation, or deflation.
Compound Interest Clubs have no management fees, no performance fees, and they trade on the New York Stock Exchange. As such, the minimum investment is one share.
A Compound Interest Club is my name for a rare breed of insurance company that employs both a brilliant underwriter AND a brilliant investment manager. When these two forces work together for many years, amazing profits results.
Warren Buffett is the world's second-richest individual... and the world's most successful investor. When people think of Buffett's best investments, they think of See's Candies, Coke, or Wells Fargo. But which industry should take the most credit for Buffett's success?
Insurance.
Look up Larry Tisch, founder of Loews Corp. He used insurance to build a billion-dollar fortune. So did Henry Singleton, founder of Teledyne.
Insurance may or may not be a great business... but it provides the perfect platform for astute money managers.
Policyholders pay premiums every year. These premiums create a massive river of cash flowing into the insurance company, day after day. The insurance company must invest this cash until the claims come due. In the business, they call this money the "float." Because there's no way to predict when a policyholder might make a claim, the insurance company must invest the cash in liquid investments... stocks, bonds, and other marketable securities.
A well-run underwriting business (underwriting is the insurance side of the insurance business) will bring in more cash than it pays out. So the amount of cash under management grows all the time. When you let a world-class investor like Warren Buffett manage this pile of growing money over a period of 30 or 40 years, billion-dollar fortunes result.
It comes back to compounding. The underwriting business is adding money into the pot every year. Interest and dividends from the investment portfolio are getting reinvested. Two sources of income are flowing into the cash pile. Invest this money for a 5% or 10% annual return and the pile slowly compounds into a billion-dollar fortune.
To find an insurance company that meets these criteria, you'll have to study them individually. One quick test to tell if an insurance company might qualify as a Compound Interest Club is to study the long-term growth of its book value. If it's grown book value at a rate of at least 10% a year for more than 15 years, then you've probably found one...
Or you could just invest in Berkshire Hathaway, Warren Buffett's holding company. It's the ultimate compound interest club. But Berkshire Hathaway is a mature business and, as Warren Buffett said himself, you shouldn't expect more than 7% annual compound growth in book value going forward...
Good investing,
Tom
P.S. In my latest issue of The 12% Letter, I tell my readers about my favorite Compound Interest Club. It has compounded book value at 24% a year since its founding in 1985... and in 2008, it grew book value by 21%.
For more information on The 12% Letter, click here...
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