1% IRR Project: Enduring Principles

Pathway v 3.0

1% IRR Project — Tue, 26 Aug 2025 15:06:15 GMT

“The big money is not in the buying and selling, it’s in the waiting.” - Charlie Munger

The Siren Song of Compounding

Charlie Munger’s wisdom encapsulates the essence of successful investing: find a few great stocks, hold them for decades, and let the beauty of compounding work its wonders. After a long period of riding a winner, massive wealth seems assured, leaving only the pleasant dilemmas of which non-profits to endow and how to pass on the largesse to heirs.

This idyllic outcome appears even more self-evident when we reflect on our personal experiences. We often think, “I’d be so much wealthier if I had just bought Apple when the iPhone launched, or Netflix when I first subscribed, or even Microsoft when I was frantically typing my midterm essay.” Indeed, a substantial investment years ago in any of today’s great businesses would have led to remarkable wealth creation.

The Missing Piece: The Pathway

However, this retrospective view overlooks a crucial element – the Pathway. What transpired during those years before these stocks reached the promise land? Was it a smooth ascent towards inevitable greatness, or were there periods of uncertainty, doubt, or even existential threats?

The more important question is: how would you have responded when faced with adversity? Would you have calmly brushed off the volatility, confidently knowing the stock would perform exceptionally well in the decades to come? Or would you have capitulated and sought safer havens?

Deconstructing the Pathway

The purpose of the 1% IRR Project is to deconstruct investing into first principles so that they can be reconstructed for better decision-making.

In this breakdown, we deconstruct “The Pathway” - the route stock prices of some of today’s great businesses have taken to reach the mountain top.

Understanding Historical Returns

Our analysis reveals that most stocks fail to outperform the broader market, with less than 10% achieving annualized returns above 15% over a 5+ year holding period.

The chart below illustrates the 20-year annualized returns of big winners - stocks that have compounded at 15% or more annually. (This is not a comprehensive list).

20-Year Returns of Big Winners

Yellow = SPY (S&P 500 ETF)

Annualized Returns of stocks over a 20-year period

To illustrate the dramatic impact of compounded returns, the table below shows the growth of a $1,000 investment at different annual returns over a 20-year period. For a comprehensive compounding table, see here.

The Cost of Success: Depth x Length

While the long-term returns of top-performing stocks are impressive, it’s crucial to understand the volatility experienced along the way, which unfolds in two ways:

1. Max Drawdown

Most big winner stocks have experienced larger drawdowns than the S&P 500 at some point in their history. The psychological impact of losses often outweighs the pleasure of gains, which means a large drawdown could potentially lead to irrational behavior like selling at a low.

Max Drawdown over a 20-Year Period

Yellow = SPY (S&P 500 ETF)

Max Drawdown = Highest percent drop from a previous trading high. For example, if a stock traded at $100 and fell to $45, its drawdown is 55%.

2. The Challenge of Waiting

The intensity of a drawdown alone fails to convey the full challenge of the investment journey, particularly the prolonged duration of a drawdown.

% of Days Below a 50% Drawdown

Yellow = SPY (S&P 500 ETF)

The number of trading days the stock traded below 50% of a previous high. For example, if a stock traded at $100 then fell below $50 and stayed at that level for 10 years, it would trade 50% of Days Below a 50% Drawdown.

Case Study: MSFT vs S&P 500 – Compounded Returns vs. Drawdown

Consider Microsoft, a company that has always seemed destined for greatness. Over the past 20 years, it spent more than 10% of the time (529 trading days) trading below 50% of its previous high watermark. That’s equivalent to more than two calendar years of trading! In contrast, the S&P 500 index spent only 0.3% of the time in such a position.

Focusing on the challenging times misses the main point – MSFT compounded at 17.4% or a cumulative 2,377% over the last 20 years, while the S&P 500 compounded at 10.6% or a cumulative 652%. This is the historical proof that long-term investors should prefer a “lumpy 15% to a smooth 10%.”

The Psychological Toll

The rub of earning all that extra cash from holding a company like Microsoft is partially the volatility and partially the waiting. The effect of those 529 days shouldn’t be underestimated.

Imagine investing a significant portion of your net worth into a stock, only to see it drop by 50%. How would that feel? Now, amplify that feeling by the days, weeks, and months of mental strain.

How would you handle the scrutiny from family, friends, and colleagues questioning your decision? Is your support system truly supportive?

The point is, a drawdown isn’t typically a brief event lasting a day, a week, or even a month. As Microsoft’s history shows, there can be long periods of feeling foolish. This is a true challenge of long-term investing. The math may be elegant and inviting, but the path can be daunting. Long-term investing can be incredibly rewarding, but one must be prepared for the difficulties that lie in waiting.

Key takeaways:

1. Everyone can be Warren Buffett in theory, but there is only one in practice.

2. Investors often buy great businesses but may capitulate at the worst possible times.

3. Long-term investing requires understanding that rough patches are par for the course.

4. Recognize that these challenging periods can be both dramatic and prolonged.

5. Build safeguards into your investment process and mentally fortify yourself during good times to withstand challenging periods.

Looking Down Before Looking Up – Part 2

1% IRR Project — Tue, 26 Aug 2025 14:57:58 GMT

This is a companion piece to "Look Down Before Looking Up - Part 1." In part 1, we explored that a significant proportion of stocks have negative lifetime returns. In Part 2, we review data about the winners.

1% IRR Takeaways:

Since the inception of the S&P 500 in its current form, the index has compounded ~10.3% per year from 1957 to 2023.
While the stock market goes up over the long term, stocks do not. From 1926 to 2023, ~52% of stocks listed in the US have negative lifetime returns.
Data analysis reveals that a few businesses are responsible for driving stock indices higher.
Whether you are a “look for the winner type” or an “avoid loser type” isn't important. However, understanding your archetype is.

Defining Investment Success

Key Point: A “good investment” is one that generates returns surpassing an objective benchmark, not merely yielding a positive return.

The primary goal of investing is to enhance future purchasing power. Various investment vehicles exist to achieve this objective, ranging from low-risk treasuries to higher risk options like stocks, private investments, commodities, etc.

Investing in the U.S. economy has been a remarkable strategy over the past century. The S&P 500, a market-cap weighted index of the 500 largest U.S.-listed companies, serves as an excellent way to invest and gain exposure the U.S. economic spirit.

For investors venturing beyond index funds, the S&P 500 provides a crucial benchmark for measuring opportunity cost. Therefore, the index becomes an objective standard for comparison when analyzing the historical performance of individual stocks.

First Principles - Evaluating Historical Data of Individual Stocks

Looking Up

By analyzing the history of all U.S. stocks from 1926 to 2023 (Hendrik Besseminder, professor at Arizona State University, has done excellent research compiling and analyzing historical stock prices), certain patterns emerge.

Focusing only on the positive outcomes:

~48% of all stocks produced positive lifetime returns
~28% of all stocks achieved annualized returns exceeding 10%
The percentage of outperforming stocks decreases when factoring in holding periods

Focusing on companies that have existed for more than 5 years (a proxy for long-term investments), the data tells a more challenging story.

Data Story - Understanding Historical Stock Returns

Picking winning stocks has historically been a coin flip (Figure 1).

However, finding the companies that compound at above market rates for long-term periods offers odds more like rolling a die and betting only on 6.

The data underscores a crucial point: of all the 28,843 U.S. companies ever listed, fewer than 3,000 have provided annualized returns exceeding 15% over a 5+ year holding period. Additionally, with so many negative-performing stocks, the indices are driven higher by a fraction of stocks.

Fork in the Road

Investors will have a natural predilection when considering investment decisions and typically fall into two categories:

(1) Those who seek winners

(2) Those who aim to avoid losers

Every person has a genotype (an organism’s genetic information), and phenotype (a set of observable traits). In a study published January 14, in Nature Genetics 2019, an international research team identified 124 genetic variants associated with a person’s willingness to take risks.

Key points:

There is no individual variant that meaningfully affects a particular person’s risk appetite.
Non-genetic factors, i.e., life circumstances, matter more for risk tolerance than genetic factors.

While genetic factors play a role in risk tolerance, life experiences and circumstances weigh more significantly on our risk-taking behaviors.

Investor Archetypes

1. The Entrepreneurial Optimist: Focuses on potential upsides and sees promise in various businesses.

2. The Distrusting Pessimist: Views C-Suite executives with skepticism and is concerned about shareholder exploitation.

Both types of investors are right and wrong. It’s not important to be one or the other, the key is to recognize your inherent bias.

In a recent interview, Reed Hastings, co-founder and executive chairman of Netflix, made this confession – “If you mean financial investments, the few times I’ve done investing, I’ve lost my shirt and I realize I’m just so optimistic. I like anybody who seems to have a good idea, I’m like, “Sure.” So I think it’s a different DNA than investors have that are differentially good investors. So I’m a pure index fund investor. I’m Netflix plus index fund.”

Mr. Hastings comment exudes self-awareness. Not everyone has to take such an extreme approach, but guardrails around optimism are important.

1% IRR Improvements:

Statistically, finding winning stocks is challenging. For any random stock, it’s more likely to lose money than beat an index.
Know thyself: If you are an optimist, look down before you look up.

As Ben Graham once said: “The intelligent investor is a realist who sells to optimists and buys from pessimists.”

Disclaimer:
The content published on The 1% IRR Project is provided for informational and educational purposes only and does not constitute financial, investment, legal, or other professional advice. The author is not a registered investment advisor, broker-dealer, or financial planner. Nothing on this site should be construed as a recommendation to buy or sell any securities or to make any financial decisions. You should consult with a qualified financial advisor or other licensed professional before making any investment or financial decisions. All views expressed are solely those of the author and are subject to change without notice.

Look Down Before You Look Up – Part 1

1% IRR Project — Tue, 26 Aug 2025 01:48:40 GMT

In 1985, Warren Buffett made his television debut on PBS’s “Adam Smith’s Money World.” The first words he uttered during a humble seven-and-a-half-minute appearance were:

“The first rule of an investment is: Don’t lose. And the second rule of investment is: Don’t forget the first rule. And that’s all the rules there are.“

While seemingly simple, Buffett’s rules are almost mathematically impossible. Nevertheless, the core message is clear: prioritize the downside and let the upside take care of itself. In other words, “look down, before you look up.”

The purpose of the 1% IRR Project is to deconstruct investing into first principles such that they can be reconstructed for better decision-making.

To deconstruct the potential outcomes for a long-term investor, a good starting point is to look at the history of stock prices over a long period of time, ensuring consideration of various economic cycles.

Breaking into First Principles: Evaluating Historical Data

Looking Down: A Sobering Reality

Certain patterns emerge when analyzing the history of all U.S. stocks from 1926 – 2023 (Hendrik Besseminder, professor at Arizona State University, has done excellent research compiling and analyzing historical stock prices).

Focusing on the Negative Outcomes:

- Approximately 52% of all stocks had negative lifetime returns

- About 33% of all stocks lost more than 75% of their value. In other words, when stock prices fall, they fall hard.

A similar study from JP Morgan analyzed the lifetime returns of all stocks in the Russell 3000 from 1980 to 2014 or until a firm was acquired, merged, or delisted.

Summary of the Negative Outcomes:

- Roughly 40% of all Russell 3000 stocks had negative absolute returns.

- Comparing stock prices against the Russell 3000 index, the median stock underperformed by an excess lifetime return of -54%.

- About 66% of stocks had negative excess returns vs. the index.

The difference between the studies is likely due to JP Morgan’s study (1) excluding micro-caps and (2) evaluating market data during a secular bull market.

Key Takeaways:

- Many stocks will fail. Statistically, when evaluating an investment, it’s a coin flip whether it will work.

- Markets go up but stocks go down. The data looks even bleaker when comparing against a market index since 2/3^rd of stocks historically underperformed the market.

The Creative Destruction of Capitalism

The byproduct of a healthy capitalist system is that many companies will be destroyed. In Joseph Schumpeter’s classic work, “Capitalism, Socialism, and Democracy”, he made this poignant assertion about capitalism:

The opening up of new markets … and the organizational development … illustrate the same process of industrial mutation—if I may use that biological term—that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism [emphasis added].

The steady-state of a capitalist society is that the old will give way to the new. As new industries emerge, old ones decline or disappear entirely, driving economic evolution. This is an endless cycle.

Accelerating Creative Destruction

A 2016 study by Vijay Govindarajan of Dartmouth's Tuck School of Business analyzed 29,688 firms listed from 1960 through 2009.

The paper’s abstract tells the story:

Life is short. That’s never been more true for corporations today. An analysis of all 29,688 firms that listed from 1960 through 2009, divided into 10-year cohorts, reveals that newly listed firms in recent cohorts fail more frequently than did those in older ones. Creative destruction is accelerating because there is a fundamental shift in the American economy. The pre-1970 firms tended to be heavily invested in physical infrastructure, such as factories and inventories. Later cohorts have relied increasingly on intangible assets, such as databases, proprietary algorithms, and expert workers. This transformation is a double-edged sword. The good news is that newer firms are more nimble. The bad news for these firms is that their days are numbered. That is, unless they continuously innovate.

Corporate Survival

Key Takeaway:

- Corporate mortalities are accelerating.

- The weighting of companies built upon hard assets is declining while soft-asset companies are rising.

- Soft asset companies generally have fewer barriers to entry, and therefore higher mortality rates.

1% IRR Improvement:

Understand the game that is being played.

o Recognize that a healthy capitalist system naturally destroys businesses.
o Acknowledge the accelerating pace of destruction.
o Realize that many of today’s companies will not be around in 5 years, less in 10 years, and even fewer in 20 years.

A mountain climbing analogy:

o If ~50% of climbers fall on a certain path, you will be cautious.
o Knowing that an increasing number of climbers are falling earlier in their journey, you will be even more vigilant.

In other words, you will look down before looking up.

Part 2 will explore “Looking up” or the state of winners.

What is Signal? What is Noise? (Part 1)

1% IRR Project — Thu, 14 Aug 2025 16:30:28 GMT

Key Takeaways:

The growth of Noise has been unprecedented and accelerating.
Technology continues to evolve to generate more Noise, rather than filter it out.
AI is rapidly amplifying Noise production.
Going forward, Noise will increasingly challenge decision-makers across all fields.

In an ideal world, you could effortlessly filter out unnecessary information (Noise) and focus solely on meaningful data (Signal). You would curate your information flow to include only relevant materials that inform decision-making.

However, the sheer volume of data growth is making it impossible to passively absorb information, making it increasingly difficult to find the Signal.

Noise vs. Signal

The purpose of the 1% IRR Project is to deconstruct investing into first principles so that they can be reconstructed for better decision-making.

To deconstruct Signal vs. Noise, it’s crucial to understand the current state of Noise. Being aware of the increasing trend of Noise helps frame the search for Signal.

Part 1: The Noisy State of Noise

In 2003, Google CEO Eric Schmidt stated: “Every two days now we create as much information as we did from the dawn of civilization up until 2003. That’s something like five exabytes of data.”

He added, “The real issue is user-generated content.”

This comment predates Facebook’s founding in February 2004.

Since then, data has exploded.

DOMO, Inc., a data science company, has been publishing “Data Never Sleeps” since 2013, providing insights into the amount of data being generated and published every minute of every day.

In 2013, a subset of the stats per minute included:

YouTube users upload 48 hours of new video
Instagram users share 3,600 new photos
Brands and organizations on Facebook receive 34,722 “likes”
Over 100,000 tweets are sent

A decade later, the growth has been staggering.

This trend extends beyond user-generated content to include economic indicators. According to Nate Silver, the U.S. government provides over 45,000 economic indicators, with another 4,000,000 from the private sector.

The Future of Noise

The astonishing part of the data reviewed thus far is that it is before AI is auto-creating billions of pieces of information. There is a storm cloud of Future Noise on the horizon!

In February 2024, Sam Altman tweeted “openai [sic] now generates about 100 billion words per day …”, which the NY Times characterized as “a million novels’ worth of text every day …”

NewsGuard, a website dedicated to tracking misinformation, has identified 1,075 AI-generated news and information sites operating with little to no human oversight.

It’s important to recognize that AI is still in its infancy, with exponential growth expected.

By-Products of Noise

Financial markets will likely be affected by increasing Noise levels, potentially leading to more volatile moments.

More critically, market participants are faced with a challenge – excessive Noise impacts thinking itself. In the search for truth, the road is paved with relevant information. The prevailing viewpoint is that more data is better. While curiosity drives the search for more information, there is an argument that sifting through Noise could be counterproductive. Afterall, it steals a precious commodity – time.

1% IRR Improvements:

First Principle: Recognize the sheer volume of Noise
Anticipate the impending surge in Noise.
Develop strategies to effectively filter Signal from Noise, a topic we will explore in subsequent essays.

When Noise Becomes the Greatest Signal in the Universe

Here is the original story published in PBS. It is short and worth the read, however, for the TL;DR - below, is the ChatGPT summary 😉 …

In 1960, Bell Labs built a large antenna in Holmdel, New Jersey, for an early satellite transmission system called Echo, which bounced radio signals off balloons in the atmosphere. However, the launch of the Telstar satellite soon made the Echo system obsolete. Two radio astronomers at Bell Labs, Arno Penzias and Robert Wilson, wanted to use the Holmdel antenna for research, and when Telstar was launched, the antenna was freed up for their work.
As they began using the antenna, they encountered a persistent noise, a microwave signal coming from all directions. After ruling out various potential sources—such as interference from the city, the galaxy, and even pigeon droppings—they concluded it was not a technical issue.
At the same time, physicist Robert Dicke at Princeton was developing theories about the Big Bang, predicting that the explosion's residue would be a low-level background radiation across the universe. When Penzias and Wilson contacted Dicke’s team, they realized they had inadvertently discovered this cosmic background radiation, supporting the Big Bang theory. Penzias and Wilson’s work, published in collaboration with Dicke, earned them the Nobel Prize in Physics in 1978. Their discovery became key evidence for the Big Bang and reshaped the field of cosmology.

Take-away:

Sometimes, Noise = Signal!

Compounding Part 1

1% IRR Project — Thu, 14 Aug 2025 11:52:11 GMT

“. . . ’tis the stone that will turn all your lead into gold... Remember that money is of a prolific generating nature. Money can beget money, and its offspring can beget more."

-Ben Franklin

Key Takeaways:

Compounding is arguably the most important concept in investing.
Compounding is conceptually simple but often thought of as a “complex calculation”
Understanding and implementing compound calculations are two different modalities, with implementation being more difficult
“Insite, In Mind” is a useful method - detailed below.

To help understand compounding’s powerful effects, stories and tools are shared such as The Game of Rice; pithy quotes from Einstein about compound interest being the 8th wonder of the world, and of course the standard compound interest table (a financial advisor favorite).

Such rhetorical devices are helpful to fire up the mind, but the lesson can be fleeting. Not for lack of want, but for lack of use. Most folks consider linear calculations the default state - simple math at the grocery store or a restaurant, or when calculating travel time. Percentages are another default computation, and for the most part they are a linear extension. Meaning, 20% of a $100 restaurant bill is $20. The next step is the summation. From there, our math work is done, and we merrily go about our day (depending on the quality of the meal).

There are few daily circumstances that require thinking in terms of compounding.

For investing, however, thinking in exponentials is all that matters. The math required to calculate a one-year gain is linear – a $100 investment earns 7% therefore, I have $107. However, the math used to understand how long it takes to double your money from an investment earning 7% annually is more complicated. The Rule of 72 is a quick shortcut. -- simply divide 72 by the annual rate of return. In our example, 72 / 7 = ~10.2 years, so our money doubles in about 10.2 years.

Making Compounding the Default Calculation:

As investors, our concern is how to make exponential math a default mental model as opposed to a tool-based approach (e.g., using Excel)?
Compounding calculations should be ensconced as the base case, and we must revert to linear calculations.
Charlie Munger provides a great answer we call “Insite, In Mind”

As described in a January 1996 article from Forbes featuring Munger on the cover:

Buffett and Munger share a deep respect for the awesome, mysterious power of compound interest. Charlie Munger loves to quote his hero, Benjamin Franklin, on the subject ... (recall the quote above).

Munger is rarely without a compound rate of return table. He illustrates its magic by taking an investment of $1 and demonstrating that a return of 13.4% a year, after taxes, over 30 years, will make that $1 worth $43.50. To Munger it's much better to depend on compounding than on market timing.

“Understanding both the power of compound return and the difficulty getting it is the heart and soul of understanding a lot of things,” says Munger in typically grandiose terms.

1% IRR Implementation:

Always have a compound interest table (aka “Munger Table”) readily visible.

I keep mine on my desk. Looking at the table is a forcing function for long-term thinking. The dollar value of compounded money is so great that it becomes a habit to obsess over the long-term outcomes of decisions; a byproduct is eschewing the search for short-term gains.

Pro Tip: I highlight the 30-year, 15% Annual Return (why aim low?). Without looking, can you guess the compounded return? See the green highlight below for the answer.