Buffett’s Folly
I was fortunate enough to see Warren Buffett and Charlie Munger in person at the Berkshire meetings several times. Their wit and common-sense wisdom never ceased to amaze me.
One of the many lessons I’ve internalized from Buffett over the years is the reality of opportunity costs. Here’s how Buffett thought about them (both quotes taken from his Snowball biography):
“Do I really want to spend $300,000 for this haircut?” was his attitude. If Susie wanted to spend some trifling sum of money, he would say, “I’m not sure I want to blow $500,000 that way.” But since Susie wanted to spend money that he wanted to withhold, and since he wanted Susie to be happy and she wanted to please him, their personalities were gradually meshing into a system of bargaining and trades.
Another story:
With momentum behind him, Warren realized it was time to leave a house where there was barely room for a family with two young children—one an unusually energetic three-and-a-half-year-old—and a third on the way. The Buffetts bought their first house. It stood on Farnam Street, a Dutch Cape set back on a large corner lot overlooked by evergreens, next to one of Omaha’s busiest thoroughfares. While the largest house on the block, it had an unpretentious and charming air, with dormers set into the sloping shingled roof and an eyebrow window. Warren paid $31,500 to Sam Reynolds, a local businessman, and promptly named it “Buffett’s Folly.” In his mind $31,500 was a million dollars after compounding for a dozen years or so, because he could invest it at such an impressive rate of return. Thus, he felt as though he were spending an outrageous million dollars on the house.
Frugal Professor’s Folly
We bought a Tesla a little over a year ago. Since we don’t hold cash, we had to sell stocks to buy the car. Here’s the related trade confirmation:
We sold 435.927 shares of VTSAX @ $109.00/share to produce the $47,516.04 of liquidity we needed. Technically we got a $7,500 tax credit to bring the purchase price to $40k before tax, but we also had to pay sales tax, registration, etc.
Out of curiosity, I looked up how much those 435.927 shares of VTSAX would be worth today (including reinvested dividends) had we not bought the car. The answer was $66k — about $20k more (or 39%) than our purchase price (portfolio visualizer link).
The Real Cost of Our Tesla
Our Tesla purchase a year ago has cost us $66k of wealth today. What makes this example so poignant is that the opportunity cost is so explicit — I have the actual trade confirmation as a record and can perfectly calculate what those shares would have been worth today had we remain invested.
Had I possessed the elusive crystal ball, I certainly would have deferred the purchase a year. Alas, I didn’t have one and I did not foresee the 39% return over the past year.
For the record, Tesla pricing has stayed stable or fallen slightly from when we bought our car (link to current inventory discounts). If you are interested in taking the plunge, use a referral to save another $1k (whether it’s mine or someone else’s). After tax credits and the $1k referral discount, the cheapest Model Y in my area is $35,650 (demo with 45 miles) or $36,570 (with 0 miles) today. A reason to not buy a Model Y today is that the redesigned version is almost surely coming next year, which will have some upgrades (better efficiency/range, ventilated seats, quieter).
The Real Cost of Every Dollar that Leaves your Wallet
In real life, calculating opportunity costs is more challenging since there is usually no “sell” transaction corresponding to every purchase we make in our life. Nonetheless, these opportunity costs are every bit as real as my Tesla example. Every single dollar spent in your life is a dollar that could have otherwise been invested. Similarly, every single dollar held in uninvested cash incurs the opportunity cost of the forgone investment returns had that dollar been invested instead.
Each $1 spent a decade ago could have otherwise been transformed into $2.48 (=$1*(1+148%)) of wealth today had it been invested in a VT ETF, for example. Admittedly, inflation would have eroded some purchasing power but there is still a good amount of “real” return remaining.
So Opportunity Costs Imply we Should Spend Nothing, Right?
If we all thought like Buffett (or perhaps FP), the logical conclusion would be to miserly hoard and invest 100% of our income so that we can spend lavishly in our 90s, right? Think of how many Teslas we could buy on our deathbeds!
Of course, that isn’t how life works. We get one shot at it, and as far as I can tell VTSAX positions don’t matter when you’re dead (though arguably they matter to your heirs…).
The tension, of course, is to figure out when to optimally consume — now vs later (vs never if leaving to heirs). Financially, we incur the largest opportunity costs if we spend now — this is how Buffett’s & FP’s minds work. However, if we defer consumption then we incur the opportunity costs of forgone “memory dividends” as explained by the excellent chart in the Die with Zero book:
How I Think About the World
All of economics/finance is built on the foundation of “utility” curves, which is an attempt to quantify how much enjoyment (or “utility” in econ jargon) people get out of spending. Nobody really knows what these functions look like in the real world, but economists approximate utility using mathematical equations like u(c) = ln(c). Nobody knows that the “right” utility function looks like — and surely utility functions vary across people — but attempts to model utility functions come with few basic and reasonable properties. First, the more you consume, the more “utility” you derive out of your consumption. Second, there are diminishing returns to each dollar of spending. In other words, the first thousand dollars you spend will bring far more happiness than moving from $100k to $101k in annual spending.
I’m no expert in utility functions, but observing the world around me (not reading academic papers) has informed how I view the topic.
My first observation is that most people live in the red line in the chart below. Their spending is pretty unintentional and filled with wasteful spending (carrying unused subscriptions, carrying credit card debt, etc.). If they were to be more intentional instead, perhaps that would get them to the blue line in the chart below. Holding a given level of spending fixed, an optimized spender will derive more enjoyment out of than someone who didn’t optimize by moving up in the chart (as shown in the A arrow in the chart). Alternatively, an optimized spender in the blue line can achieve the same amount of happiness as someone on the red line at lower levels of spending (the B arrow in the chart).
The entire premise of this blog is trying to help readers shift from red to blue by picking up proverbial dollars on the ground.
However, I think I was born with a utility function that looks a lot like the green one below. I’m pretty content with a modest level of spending and I have yet to find any meaningful ways of spending more money to materially affect my happiness — with the recent exception adding Darn Tough Socks to my life, which you can pry away from my cold dead feet. In other words, I think I’ve found point C on the chart. Looking at my green utility curve, it’s easy to reconcile our family’s spending behavior. We spend up to C since we have the financial means, but spending beyond C seems silly and wasteful.
(As an aside, I’m open to suggestions for other life-changing products like Darn Tough Socks that could add value to my life.)
To summarize, getting from red to blue takes some intentionality when structuring your financial life. To get there, you’d deliberately spend where it gives you the greatest amount of happiness, invest in tax-efficient vehicles, use the “right” credit card, cancel unused or underused subscriptions, etc. In other words, you would cut out the waste and pick up the free proverbial dollar bills on the ground. I’d argue that almost the entire premise of this blog is to help people pick up these proverbial dollar bills on the ground.
How to Get to Green?
Going from blue to green, however, requires a shift in mindset. Maybe some people are lucky enough to be born with a disposition that makes them easily pleased. Perhaps it can be acquired by traveling and experiencing different ways of life, by practicing gratitude or mindfulness, or through service to others. I don’t know exactly why my brain works the way it does, but I’m glad that I’m not stuck in the rat race of keeping up with the Joneses. Life along the green plot is much simpler.
Conclusion
I think it is absurd to be a passive participant in your financial life, mindlessly spending along the red line above. Yet most people I observe seem to behave this way. Hence the blog, I suppose.
If you can somehow figure out how to shift your utility curve from blue to green, it has the potential to unlock a superpower in which your happiness is largely uncorrelated with your spending once you hit a modest C point.
I wish our society would talk more about how to shift to green. Do you have a greenish utility function? If so, I’m curious to hear how you got there. Was it innate or did you actively work to cultivate it?
My idea of having a good time involves sitting around and doing math with friends. That costs nothing. I think the kind of person who would even consider whether to go to grad school vs work is more predisposed to being somewhere in the blue to green region. I think it’s innate and correlates with IQ. We could also frame it as someone with a fast life history strategy vs a slow one.
I will say that while my frugality was innate, it was only upon being exposed to the concept of FIRE that I linked together frugality with the ability to shave off decades from my working career doing something I didn’t like. Ironically, typical salaries are far higher than what I require, so I can do what feels to me like splurging and still be able to save a lot of money. For example, if you only buy lottery tickets when the jackpot is north of $500M, then you end up spending maybe $100/yr. Yes, it’s negative EV, but it’s also far less than 1% of my salary.
At some point you run out of things to spend on for yourself and can spend on others. If I did win the lottery, I’d put it towards advancing permaculture, regenerative agriculture, and scaling up the work of a few people I know that teach K-12.
I’ve never done math with friends; it sounds impressive! However, I’ve played countless hours of strategic board games with friends & family and it is a favorite past time of mine. We are a board game family.
I think my story maps to yours pretty well. I was a born saver as well and didn’t realize the implications until doing the math on the FI stuff. It’s pretty liberating. The opposite is to be stuck on the hedonic treadmill, which is what everyone else does. Seems exhausting.
I love this post! I’ve often thought about Buffet’s $300k haircut quip.
I think it’s quite easy to be the red line when that’s the behavior you’re most familiar with others portraying. For me, it was being introduced to FI blogs in college and learning about compound interest that switched my mindset. I had to be influenced to see the different way of thinking to understand there is no utility in $100 jeans.
As an aside, I saved ~$200k for a down payment in cash and now I don’t think I will need that. Would you recommend lump sum investing this money? Or dollar cost averaging over a few months? Your line in the post made me feel guilty about this money just sitting there!
> Similarly, every single dollar held in uninvested cash incurs the opportunity cost of the forgone investment returns had that dollar been invested instead.
The red line is indeed where most people are. It’s easy to be there. Simply take a passive role as a consumer and let the dollars fly out of your wallet without any intentionality. But this behavior course come without a cost, of course…
Regarding your $200k down payment, congrats! Why do you no longer need the $200k? Have you decided to never buy a home?
The rule of thumb I use with stock investing is to not invest unless I’m willing to lose half tomorrow. Applying this to your $200k, if you’re comfortable losing $100k tomorrow, then dump it in the market. If not, then you can dollar cost average over time to reduce the timing risk.
The math says you come out ahead with lump sum investing, but it’s riskier… Good luck!
We will be using a VA loan with no PMI, so it seems we will not need to put any money down. $200k is also more than we will need to put 20% down on any house we are considering.
Congrats and good luck!
I don’t have darn tough socks, though I’ve thought about em for hiking/rucking…. I probably should grab a pair before my next long trek!
My life-changing product suggestion is…. the ninja creami. It’s loud as can be but blows my mind every time I eat ~half a pint of ice cream with ~350kcal and 40-50g protein plus 5-10g carbs and fat depending upon the day/flavor I roll with (vanilla whey + peanut butter powder is my go to…everything else is just variety to make it more delicious next time lol)
Looks like they sell it at Costco: https://www.costco.com/ninja-creami-deluxe-11-in-1-ice-cream-and-frozen-treat-maker.product.4000213642.html
What is your recipe exact recipe? Does your vanilla whey have sugar in it? Have you tried Costco’s (new) protein powder yet? https://www.costco.com/kirkland-signature-whey-protein-creamy-chocolate-54lbs.product.4000287218.html. We like it pretty well. It’s cheap, so it has that going for it….
I’m with you on the Darn Tough Socks! I always said there is no way I would ever spend that much on a pair of hiking socks. Then I received a gift certificate to an outdoor store and picked up several pair. Will never go back!
Darn Tough or death.
I feel seen!
Please elaborate.
DeFeet Woolie Boolie socks are even better. Comfier & don’t stink.
Airdry on a Moerman 88346 Y-Airer them and they’ll last forever.
And replace your laundry room light with a combo ceiling fan light and they’ll dry faster
Darn tough has a lifetime guarantee. Does DeFeet?
What arrows could you put on here that would represent un-optimizing your spending? Letting go of the time and effort effort of deciding (and keeping your spouse up to date) which credit card is optimal, worrying each month whether you have one too many streaming services, etc? Is that simply moving right on either curve, spending more for a marginal increase in happiness?
With you on the credit card debt, though.
You sentiments are reflected in the excellent Die with Zero book. I have no qualms with your points if you are sitting on $100M like the author of the book. But if you are sitting on $50k, perhaps it’s not futile to pick up free dollar bills on the ground as they arise.