I went thrift-store shopping with Kris yesterday. I scored a pile of personal finance books, including a copy of The Only Investment Guide You’ll Ever Need by Andrew Tobias. This is one of my favorite personal finance books. Tobias has a witty, engaging style, and the book is full of down-to-earth tips.

Remember how cranky I was about Amelia Tyagi’s advice to not worry about the little things, to only pay attention to the Big Picture? Tobias has some great examples of why the little things matter, including this classic bit about how to make a phenomenal return on your investment by purchasing wine in bulk.

Earning 177% on Bordeaux

by Andrew TobiasThis example has sort of evolved. The first time I used it was in 1978, on the

Tonight Show. Say you bought a $10 bottle of wine for dinner every Saturday night, but could instead get a 10% discount buying by the case. You’d “make” 10% the extra money you tied up. And you’d “make” it in just 12 weeks — a bottle a week for 12 weeks equals one case of wine — which works out, I explained, to “better than a 40% annual return.”I didn’t explain how

muchbetter. I figured 40% was dramatic enough. Where else can you earn 40% tax free?As the years passed, I found people were having trouble understanding this little shtick of mine. Why is it 40% if I just got a 10% discount?

So I tried explaining it in a little more detail. What actually happens, I explained, is that instead of going to the store and laying out $10 for one bottle, you are laying out $108 for 12 bottles (full price minus the 10% discount). The extra $98 is your “investment”. By keeping at most that much extra tied up all year, you save $1 a week on wine — $52 a year. And “earning” $52 a year by tying up $98 is earning 53%.

So now I was up to 53%, an even better tax-free return.

This confused people even more. That first $98 is gone, they would tell me, and now you have to come up with a new $98 to buy your next case of wine.

But think about it. If you were someone who planned to spend $10 a week on wine — $520 a year — and who would have LOVED to save 10% buying by the case but just couldn’t scrape up enough money all at once to do it, how much financing would you need?

Would you have to go to the bank and ask for a $400 loan in order to change your buying habits?

No, you would need only a $98 credit line — and you would only fully draw it down that very first week. After that, you would replenish it by $10 a week (the $10 you used to spend on wine by the bottle), which means that after 12 weeks, when you needed to buy the next case, you would not only have replenished the full $98, you’d actually have an extra $12 to work with (the money you saved buying by the case). So now you’d have to draw down only $86 of your $98 credit line.

In other words, to finance this change in buying habits you’d need to borrow a maximum of $98. But you’d only need to borrow that much the first week. Within 10 weeks you’d have paid the balance down to zero; then run it back up to $86 in th e13th week to buy your next case of wine; then paid that off in 9 weeks; then run it back up to $74 to buy your

nextcase — and so on. On average, over the course of the year, you are using far less than the full $98 to finance this change in buying habits.So the return on your decision to tie up that $98 at first, and then gradually less, is actually much greater than 40% to 53%.

If my friend Less Antman has keyed all this into his Hewlett-Packard financial calculator right — and I’ve never known him to err — it works out to an annualized 177% rate of return (though try explaining THAT in 40 seconds on the

Tonight Show).It’s still only $52 you’re earning — $1 a week by getting the 10% discount. But applied to all your regular shopping, it can be the best “investment” in your portfolio.

Next step: find a vintage you like equally well that’s only $8 a bottle.

So, you see? The little things *do* matter. The Big Picture matters, too, but you can’t simply focus on it at the expense of everything else. Keep everything in balance, and you’re well on your way to wealth. The Only Investment Guide You’ll Ever Need is a fun book, full of good advice. He maintains a daily weblog.

[* Do try this at home.*]

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This article is about Food, Being Frugal, Food, Funny Money

As the years passed, I found people were having trouble understanding this little shtick of mine. Why is it 40% if I just got a 10% discount?The reason that people were having trouble understanding this is that it’s utter bogus. This is the same kind of logic that leads one to conclude that “buy one, get one free” actually results in you having something for free. If you ignore a substantial portion of the investment, then yes, the return looks great. Sorry, but the answer is still 10%.

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Jeff,

Tobias is calculating the

annualreturn. Even if he’s only earning 10% on an individual case of wine (he’s not, he’s earning slightly more) the case lasts 12 weeks, so you can buy four more that year. Earning 10% more than four times in a year is a greater than 40% annual return.Not sure about the 177% though. Maybe it’d be a good exercise to try to independently derive that.

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If you earn 10% on four investments of

differentmoney, how much have you earned in a year… 10%. I.e. if you put $1000 into four different accounts each, and all four earn 10%, you have earned 10% on your $4k, not 40% on $1k. This is the bogus math that wine thing uses.loading....

And of course, implicitly, when you

buya commodity like wine, after 12 weeks, you can’t reinvest the money. You just drank it all.loading....

What if you had a savings account that returned 10% of what you invested in just 12 weeks?

On week 0 you put in $1000. On week 12 you have your original $1000 plus $100 in interest. On week 24 you have your $1000 plus another $100 (and some interest on your interest). By the end of the year your savings account has earned you much more than 10% of your original investment.

If you’re going to buy something either way, then saving money by spending less is just like earning money (except better because it’s not taxed).

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Yeah, if you had a savings account that paid out 10% every three months, life would be grand. But with the wine, the savings aren’t compounded. You put in $1000 and get $100 in ‘interest’ with savings from case discount. Then you put in

another $1000and get $100 in ‘interest’ again. Now you can compound interest on each $100 dollars of interest (assuming an additional investment with it), but that’s it.After a year, you will have spent 52 weeks*$9/bottle = $468 dollars. If you did not buy by the case, you would pay 52*$10/bottle = $520.

I suppose you ‘earn’ a little over 10%. Your ‘return’ is (520-468)/468 = 11%. Say what you like about the math, but you’re not getting $520 worth of wine for $188 dollars (which is what it would cost if you really got 177% return on your investment).

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I have read this article a couple of times and I really wish it was true. I love wine, and I love a discount and I would love to be able to wrap myself in a cloak of financial indignation and suggest that I am getting huge returns by buying in bulk… but alas it is not true. *sigh*

I played around with the numbers and I think I can see the logic fallacy so I figured I would try my hand at debunking the high returns assumption. The crux of the break down happens in this quote:

“The extra $98 is your “investment”. By keeping at most that much extra tied up all year, you save $1 a week on wine — $52 a year. And “earning” $52 a year by tying up $98 is earning 53%.”

The problem with that logic is that you are not tying up $98 only once a year and then getting $52 back at the end of the year. In the example in this article you would be tying up $98 EVERY 12 WEEKS and getting $1 each week in return.

This article totally omits the idea of when the lump sum payments are made and when thee benefit of these payments is received. The best way to visualize the timing component is to think of cost and benefit. On week 1 you buy a case of wine for $108. That week you drink a bottle of wine and you get $10 of “benefit” from drinking that bottle. So in week one you have a net loss of $98. In week 2 you pay nothing, but get $10 of benefit from the bottle, so you have a net profit of $10. Carry that process out in a spreadsheet and it should look something like this:

Week Benefit

1 $ (98.00)

2 $ 10.00

3 $ 10.00

4 $ 10.00

5 $ 10.00

6 $ 10.00

7 $ 10.00

8 $ 10.00

9 $ 10.00

10 $ 10.00

11 $ 10.00

12 $ 10.00

13 $ (98.00)

14 $ 10.00

15 $ 10.00

16 $ 10.00

And on and on. I prorated the last case purchase so that in week 49 I bought 4 bottles for $26 (this assumes the case discount still).

So just for fun use the IRR (internal rate of return) function in Excel to calculate the internal rate of return on the benefit column. It comes out to 2.04%.

So the internal rate of return for this scheme is 2.04%.

Still feel this is a great scheme?

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It’s not too heartening that you mistake “earning” with “saving”. You can’t earn money when you’re spending money. You’re merely *saving* $1/week. “Saving” does not give you “returns”. Saving is not the same as earning!!! If you bought NO wine all year, then you’d be “earning” ~700%?!?!?!?! “Earning” on what investment? “Return” on what investment? You haven’t invested in anything! You’ve just kept $1 in your pocket. C’mon now!

Selling wine… now that would allow you to *earn* money. This post makes me also wonder why I’m reading your blog for financial advice.

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Three important points I think people are missing here:

1. Tobias himself labels this a “shtick”. This is an amusement to him. Yes, he thinks it’s a good idea to save money by purchasing things in bulk, but he stuck this in the appendix of his book instead of the main text for a reason. While there’s a grain of truth to it, it’s not real investment advice.

2. The difference between earning and saving is negligible. They have the same effect. Saving 10% is the same as earning 10%, except that the savings is usually tax free. In this example, you MUST make the assumption that this purchase would be made regardless of the discount. Only then does the savings/investment make sense.

3. THIS IS IN THE CATEGORY CALLED ‘FUNNY MONEY’. This is not meant to be serious investment advice. Regardless of the fact that I am not a financial expert (just a poor schmuck learning the same as you), I do my best to provide good advice. This is labelled as “funny money” because it’s not serious.

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i am pretty good at anaylsising things like this so lets break ths down so it will make more sense

first there is the actual 10%

then there is the taxes you would have to pay for the extra ten percent on income taxes, its comparable to getting an extra part time job that pays 20 dollars a week well you would have to pay taxes on that 20 dollars. so saving on tax free income is money saved in that too

third you save the sales tax on the ten percent that your not paying

fourth a little less realized fact is inflation a bottle of wine is pretty staple but every three years the price goes up a little.

fifth there is an intangable quality to this investment since you are your own customer in this case you have a guaretee return, most business must take a risk assesment

sixth there is the money saved on gas if you are only coming to buy the wine

seventh you can write it up in your blog and continue making money from your experience

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This is an old post, but I hope someone will look at my take on it. I was wondering about the opportunity cost of tying up the “extra” $98 dollars. So I ran 2 scenarios. In both, I assumed that I have a savings account earning 4% with $480 in it (I am runing a 48 week model to avoid the pro-rated issue). In the first model, I payout 10 per week and earn interest on the remainder. In the second model, I payout $108 every the first of each 12 week block and earn interest on the remainder. At the end, I had $41.94 in my “One bottle a week” account and $85.o2 in the “Case at at 10% discount” account. So… Its definately not 177%, but its still $43. Better than a kick in the butt (as my grandma would say). Although, I like the last bit of advice best. Find an $8 bottle you like just as well. But wait! I forgot taxes… Model 1 spits out $42.08 in taxable income and Model 2 spits out $37.31. The difference is really small, but Model 2 does pull ahead a tiny bit more… Anyway, I mostly drink iced tap water

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Here’s another thought! Pay yourself in wine! Buy a case + 1 bottle every 12 weeks (using the “savings” to pay for the extra bottle) and, at the end of the year, you have 4 extra bottles of wine (great for gift giving!)

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As is the case with many problems like this, the trick is in looking at in the proper way. First the assumptions:

1) You receive a $10 salary every week.

2) You have $98 saved up (otherwise the case is impossible).

3) You must drink a bottle of wine every week.

If the %177 rate were valid, the following would be true:

Given the choice between investing your $98 in your %177 interest rate savings account, or buying wine in discount, you have no preference.

This does not hold, although the correct interest figure is still very high at ~103%.

If you think about it, a high interest rate makes sense. Your savings account (or CD, or whatever) would have to offer a ridiculous amount of interest to keep you from saving an easy $12 by buying wine in bulk.

Now the math (for simplicity, we assume the interest is compounded weekly):

If you do not buy the wine in bulk, but instead invest your $98 in a 177% savings account, at the end of 12 weeks it is ~$142.

If you do buy the wine in bulk, you cannot invest the $98, but now you can invest your $10 salary every week but the first. At the end of the 12 weeks, you have in your account ~$131, a clear loser compared to investing the money from the get-go.

Now at 103% the figures break even. Either way you ‘invest’ your $98 and your $10 salary, you will have approximately $121.60 at the end of 12 weeks.

The moral here is that it almost always makes sense to buy in large quantities at a deal rather than let that money sit in an interest bearing asset. This of course excludes any psychological effects of increased consumption from increased availability etc.

For example, say when you use up your bottle, it takes a day before you make it to the wine shop to buy another. So you actually drink wine 6 out of 7 nights. If you buy in bulk, you drink every night, (since you’ve got it on hand already) causing you to drink 1.17 times as much in an average week. So normally you go through 12 bottles in 12 weeks, but by the case, you go through it faster — 12 bottles in a little over 10 weeks. In this scenario, you end up LOSING money by buying in bulk even with the 10% discount, simply because it leads to higher consumption.

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The cost of a case of wine is 10 percent less than the cost of 12 individual bottles, so the cost of a case will be:

Cost of case = (12)($10)(1 – .10)

Cost of case = $108

Now, we need to find the interest rate. The cash flows are an annuity due, so:

PVA = (1 + r) C({1 – [1/(1 + r)]t } / r)

$108 = (1 + r) $10({1 – [1 / (1 + r)12] / r )

Solving for the interest rate, we get:

r = .0198 or 1.98% per week

So, the APR of this investment is:

APR = .0198(52)

APR = 1.0277 or 102.77%

And the EAR is:

EAR = (1 + .0198)52 – 1

EAR = 1.7668 or 176.68%

The analysis appears to be correct. He really can earn about 177 percent buying wine by the case. The only question left is this: Can you really find a fine bottle of Bordeaux for $10?

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