The news that Warren Buffett is now the world’s richest man led to the predictable round of stories about his frugal habits – the cherry coke, the well-done steaks, and the bungalow in Omaha which has been home for fifty years.

There is a point here. Like Bill Gates, whom he has toppled from the top spot, Buffett is primarily interested in the business rather than the wealth that results.  Money is a means of keeping score rather than an objective in its own right:  the fun, Buffett has said, is watching it grow.  

Albert Einstein supposedly observed that the most powerful force in the universe is compound interest, and Buffett’s frugality has enabled compound interest to work its magic.  During Buffett’s tenure at Berkshire Hathaway, the S & P index has produced an average total return of 10%.  That return reinvested over forty-two years will multiply your stake sixty-seven times.  But if your investments yield twice as much as that – as  Buffett’s have done – your wealth increases not by twice sixty-seven, but sixty-seven squared, a factor of 4500.   That arithmetic makes Buffett the richest man in the world.

The calculation illustrates a more subtle point.  Buffett’s fortune has come not through growing an investment management business, but from his own share in the value of the funds he manages.  Suppose he had adopted a more conventional investment management structure, charging the 2% management fee and 20% of performance common in private equity and hedge funds.  How much of that $62 billion wealth would have been the property of Buffett the manager –  Buffett Investment Management – and Buffett the investor – the Buffett Foundation?

The answer is astonishing.  At “2 and 20”, the split is $57 billion for Buffett Investment Management and $5 billion to the Buffett Foundation.  The effect of compounding at 14%, rather than at 20%, is to reduce the accumulated pot by over 90%.  Of course, it is unlikely that Buffett Investment Management would have reinvested in its own funds sufficiently to have grown $57 bn of assets.  There would have been bonuses to pay.  And the birthday parties!   Eat your heart out, Steven Schwarzman:   Omaha would never have seen anything like it.

You might argue that the seemingly disproportionate share of Buffett Investment Management is reasonable:  after all, Buffett Investment Management is very good.  So rework the sum on the assumption that Warren was mediocre, and performed in line with the 10% return on the S & P..  That would have reduced his wealth to $930 million, below cut off for the Forbes rich list.  But only $170 million of that more modest sum belongs to investors:  Buffett Investment Management would still have the lions’ share, at $760 million.

Worse still, suppose Buffett had been no good at all.  If returns had averaged 5% a year, then the Buffett Foundation would have a miserly $32 million to pass to Bill Gates’ charities.   But inept but thrifty Buffett Investment Management would still have accumulated $82 million.

The results of these calculations are as puzzling as they are remarkable.  But the difference between compounding before fees and compounding after fees builds up dramatically over a long period.  The Einstein quotation is almost certainly apocryphal:  but whether he said it or not, the sentiment has an element of truth

Ben Franklin discovered electricity, which probably really is the most powerful force in the universe.  But he was also impressed by compound interest and left funds to the cities of Boston and Philadelphia to accumulate for a hundred years.  Franklin did actually say that the only certain things in life are death and taxes.  He might have added another certainty:   over a sufficiently long time horizon, your investment manager will become richer than you.  The thought was certainly in his mind when he stipulated that no one should be paid for managing his legacies.

The urbane Franklin might therefore have warmed to Buffett’s homespun wisdom.  The Sage of Omaha has made more money than anyone else not just for investors but for himself without charging management fees.  In the long run, the trust of investors and of investee companies may be the most valuable asset of all – even in narrowly financial terms.  And greed may be the enemy of wealth.