Tuesday, 12 October 2010

$100 Million Problem

Once in a while, well, actually almost every day, someone on the Betfair forum comes up with a simple strategy of starting with a small bank and compounding it at the rate of 1% a day until he is a millionaire in next to no time. It would actually take about 925 days starting with a bank of £100, but you get the idea. Any fool can make 1% a day on Betfair, so all that's needed is a little patience and presto! You're soon a millionaire.

There's one thing that these challenges all have in common, and that is that they all fail.

Back in 1999, super-investor Warren Buffett said he could generate 50% returns on small sums of money. At that year's BRK shareholder meeting, he was asked:

Shareholder: Recently, at Wharton, Mr. Buffett, you talked about the problems of compounding large sums of money. You were quoted in the local paper as saying that you're confident that if you were working with a small sum closer to $1 million, you could compounded at a 50% rate. For those of us not saddled with a $100 million problem, could you talk about what types of investments you'd be looking at and where in today's market, you think significant inefficiencies exist?

Buffett: I may have been very slightly misquoted, but I certainly said something to that effect. I talked about how I polled this group of 60 or so people I get together with every couple of years as to what rate they think they can compound money at if they were investing small sums: $100,000, $1million, $100 million, $1 billion, etc. And I pointed out how the return expectations of the members of this group go very rapidly down the slope.
He continued explaining his reasoning from a financial market perspective, describing how with smaller sums of money you can look at everything in your area of expertise and find opportunities, but as the money involved increases, opportunities diminish. The same principle applies to the sports markets.
As the money goes from $1 million to $10 million, I'd say it would fall off dramatically in terms of the expected return -- because you find very, very small things you're almost certain to make high returns on. But you don't find very big things in that category today.
Same with the sports markets, although you can take off a few zeroes from Mr. Buffett's numbers. At least until I get that 1% a day system perfected...

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