This Simple Equation Mints Millionaires

|August 30, 2023

A bird in the hand is worth two in the bush, right?

That’s the old trope we took on last week. To many folks, even in the investing world, it’s a truism that can’t be denied.

Don’t give up what you have today in the hopes of getting more tomorrow. That’s what Aesop was trying to say in this oft-cited fable.

It’s lousy logic.

If you want to build wealth and be a true investor – not just a stock market gambler – it’s key that you understand why that old phrase is so much trouble… and how forgetting it can lead to reliable investment wins.

More to the Story

As we said in our column last week, this is also an idea Warren Buffett has taken on.

“[Aesop] forgot to say exactly when you were going to get the two in the bush,” Buffett says. “And he forgot to say what interest rates were.”

“If he’d given those two factors, he would have defined investment for the next 2,600 years.”

Now, if you’re a Manward Letter subscriber (and you should be!), you know we’re not one for following old-school investing theories. In this “new school” world, they simply don’t work.

But what Buffett describes above is no theory… It’s the law of the land.

Understand how to put the idea into practice, and you’ll be a much better investor.

It’s simple. There are just two factors.

  • Time value of money
  • Interest rates

We’ll start with the first… the idea that the money we have today will be worth more tomorrow.

This is critical. It forms the backbone of every economic theory.

Time Is Money

This idea is instinctual. As rational thinkers, we value a dollar today more than we value a dollar tomorrow. That’s because we can immediately invest the dollar we have today and make it worth more tomorrow.

It’s why lottery winners are almost always better off taking a lump sum. They can invest that money and make a heck of a lot more with it than they’d get with defined monthly payments.

More practically, it’s why our business vendors give us a discount for paying today… instead of 90 days from now.

They’d rather have the cash today, even if it’s slightly less than what they’d get in three months. They can immediately put the cash to use and turn it into more.

Like most things in economics, it’s quite a logical idea once we strip it down.

The Big Variable

But idea and practice aren’t always the best of friends.

The big question here is: How much can a fella make with the money he has today?

What will it be worth tomorrow?

Pay attention here… This is where great investors are made.

Buffett famously pondered the idea of getting an offer that would put two birds in our pocket five years from now.

We can accept it and double our birds in five years… but also take on some risk and lose our investing power for five years.

Or we can reject the deal and invest our cash (or birds) at the current interest rate – 5% in Buffett’s example – for those same five years.

In this case, we’d be crazy not to take the two-birds-for-one deal, even if we have to wait five years.

Doing the math, the deal effectively pays us a 14% interest rate – far better than the 5% we would earn by not taking the deal.

Hopefully you’re starting to see the moneymaking potential in this idea. But let’s keep going.

What if we woke up in a fantasyland and Jay Powell pushed rates way higher… and suddenly we could safely earn 20% on our cash?

What a dream!

Should we take the deal that puts two birds in our pocket in five years?

No.

In this case, we should invest at the 20% rate. If we do, we’ll end up with two birds in a much shorter amount of time.

Again… it’s quite simple.

The Math

For folks who like such things, here’s the formula:

FV = PV x (1 + RT)

The “FV” is the future value of your cash. The “PV” represents the present value of your initial investment. The interest rate is denoted by “R.” And the “T” represents the amount of time your money is in play.

Easy math.

All else being equal, we should invest in the asset that gives us the biggest return in the shortest amount of time.

With a simple formula, we can do the math anywhere… even in our head.

When the numbers are right, we should take the two birds in the bush every time.

It’s the idea that forms the backbone of every successful investment.

In our next essay, we’ll show you how to build on this idea to accurately value stocks.

It’s just as simple… and even more lucrative.


BROUGHT TO YOU BY MANWARD PRESS