Mohnish Pabrai, a prominent value investor overseeing approximately $900 million through his Pabrai Investment Fund, has emphasized a straightforward mathematical idea that he believes everyone involved in investing should understand: the rule of 72.
In recent discussions, particularly on the podcast CEO’s Diary hosted by Stephen Bartlett, Pabrai underscored the significance of this financial principle. The rule of 72 is quite useful for approximating the time it takes for an investment to double based on a given interest rate.
“It’s like a little math hack,” Pabrai noted in an interview. “The rule of 72 is crucial, and I truly hope we can introduce it in schools.”
The rule operates by dividing 72 by the expected annual return rate. So, if you anticipate a 7% return, your investment would double in roughly 10 years, as calculated by 72 ÷ 7. At a 10% return, it takes about 7 years, and for a 15% return, you’re looking at closer to 5 years.
“Knowing how long it takes for your money to double is really important; it allows you to do some quick calculations in your head,” Pabrai remarked. This mental agility can help investors rapidly evaluate various investment options without needing intricate calculators.
The power of compound interest
Pabrai shared a striking historical example to demonstrate the might of compound interest. He referred to the 1623 sale of Manhattan by Native Americans to Dutch settlers for just $23. “If they had invested that money with a 7% annual return for the last 400 years, they would have significantly more than just the land,” he explained. With the rule of 72, $23 would have doubled approximately every 10.3 years, leading to a staggering figure of around $23 trillion after 400 years. In contrast, today, the estimated value of Manhattan real estate is around $2.2 trillion.
Pabrai noted that even smaller amounts can grow impressively. “If we start with just 2.3 cents and let it sit for 100 years, that could also balloon to trillions,” he added, showing that time is often more critical than the starting amount.
Offering practical advice for everyday investors, Pabrai mentioned three core principles: earn more than you spend, begin investing early, and focus on broad market indices rather than individual stock picking. “You can easily open an investment account at places like Fidelity or Robinhood,” he said. “Just ask them about investing in an S&P 500 index fund, and they’ll help you get started.”
Pabrai illustrated this with his own journey, explaining how if someone starting at age 18 invests $5,000 at a 10% return, it could grow into about $500,000 by age 68, essentially doubling seven times over 50 years.
“If you keep an eye on it for a lifetime, you’ll end up with quite a bit of money,” he pointed out.
Investment leader
Pabrai’s promotion of this straightforward mathematical principle shows how understanding basic financial tenets can significantly influence investment results. His message is clear: attaining wealth doesn’t rely on complicated strategies but instead hinges on grasping the fundamental mathematics of compound interest and exercising patience over the long term. Furthermore, the ease of applying these rules can provide crucial mental shortcuts that emphasize the importance of consistent returns over chasing quick profits.
Born in Mumbai in 1964, Pabrai moved to the United States and pursued his education at Clemson University before launching his entrepreneurial career. After selling his successful IT consulting firm, he transitioned to investing, founding his investment fund in 1999. Over a span of more than 20 years, Pabrai has demonstrated an impressive track record, achieving a 517% net profit for his investors compared to a 43% return on the S&P 500 from 2000 to 2013, outperforming the market by 474 percentage points. His funds typically yield around a 25% annual return and have shown some mixed performance in recent years relative to benchmarks.
Pabrai’s investment approach mirrors that of Warren Buffett, emphasizing value and long-term growth. In a notable event in 2007, he famously paid $650,100 to have lunch with Buffett alongside fellow investor Guy Spier.
For those interested, Pabrai’s full interview on the podcast can be viewed below.
