This 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% on 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 much better. I figured
40% was dramatic enough. Where else can you earn
40% tax-free? (Uncle Sam doesn't tax you for
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
$120 less the 10% discount. Which means you
are laying out $98 more than you otherwise would
have. That 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 every 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
Would you have to go to a bank and ask for a $400
line of credit in order to be able to change your
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 habits
you'd need a maximum credit line of $98. But you'd
only actually draw down that much the very first
week. Within 10 weeks, you'd have paid the balance
down to zero, then run it back up to $86 in the
13th 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 next case and so on. On
average, over the course of the year, you're 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% or 53%.
If my good 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 $8 a bottle.
Webdesign by Marc Fest
© Copyright Andrew Tobias