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Buffett Principles: A Bird in the Hand

Value investor with a deep passion for understanding and a desire to improve results over time.

A much younger Warren Buffett

A much younger Warren Buffett

The Time Value of Money

Warren Buffett doled out some of his well-known folksy wisdom, capable of moving billions of investment dollars around, during his 2000 letter to shareholders at Berkshire Hathaway:

Indeed, the formula for valuing all assets that are purchased for financial gain has been unchanged since it was first laid out by a very smart man in about 600 B.C. (though he wasn’t smart enough to know it was 600 B.C.). The oracle was Aesop and his enduring, though somewhat incomplete, investment insight was “a bird in the hand is worth two in the bush.”

Within Aesop's famous fable, we can see a powerful lesson on the time value of money (TVM), especially one particular aspect: the opportunity cost to hold cash. Let's take a deeper look at opportunity cost as it pertains to investing, along with two other reasons that a bird in the hand is, indeed, worth considerably more than one in some proverbial flora.

What follows are three key reasons why that bird you have is worth more than an identical bird out there and how to think about it vis-à-vis investing.

1. Opportunity Cost

Buffett eloquently points out that Aesop's message isn't just that it's better to have a bird in your hand than in the bush. There's also some value for a bird in the bush relative to a bird in your hand. Figuring out this bird ratio is the essence of investing.

If you have cash in your hands and are considering investing it, opportunity cost is the first reason to understand why you would need to insist on an amount of cash greater than the amount you're investing at some future date. After all, you might want to use that same cash for an even better opportunity that comes along while you're waiting for your initial investment to come in. On a much more personal level, you might need the money for something really important, and tying up cash in an investment could mean you can't get access to that cash.

Investopedia does a great job of breaking down opportunity cost here if you want to read more on this subject.

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2. Inflation

Wrapping your head around how inflation affects your investment decisions can be challenging because, unlike opportunity cost, inflation means the bird in your hand is gradually worth less. In the four decades between 1982 and 2022, this was a largely academic concept, after Paul Volcker essentially nuked financial markets by raising interest rates all the way up to 20%. Inflation seemed destined to fall or to hover around a very low rate, around 2% per year, until 2021, when supply chain constraints and money printing woke the sleeping giant, with CPI rates approaching 10% in 2022.

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Knowing this, you're certainly more incentivized to invest sooner, since the value of your cash is all but guaranteed to decline. To some extent, the opportunity cost element is in direct conflict with the inflation element: you might want to hold onto your cash to wait for better opportunities in the future, but your cash is currently eroding away. This is going to mean a very different investing calculation when inflation rates are 10% as opposed to, say, 2%.

With higher inflation in play, your "bird in the bush" (cash that you have today) badly "wants" to be invested, but what you invest in really matters. The company should have pricing power, or the ability to pass the cost along. On the other hand, you need to consider the company's input costs: do they rely on buying a lot of a commodity in order to do business? If so, they might not be a great investment. Read more about investing during high inflation here.

3. Possible Default or Loss

Another really good reason you might be reluctant to let your cash go in exchange for something else is that the "something else" might turn out to be worth a lot less than you thought it would be. Part of this can be addressed by doing very careful analysis before making any investments, like doing discounted cash-flow valuations and the like, but making a poor investing decision based on impatience or sloppy math isn't the only reason to hesitate to give up your "bird."

There's also the very real possibility that external forces may intervene to confiscate all or part of your investment. One possible scenario is when a government turns hostile to another; if you have international investments, this is probably already on your radar. Is it possible that a foreign power could simply keep your investment? What is the likelihood? Wars, sanctions, and a very competitive, changing global landscape make it important to consider how geopolitically sensitive an investment is.

Domestic investments can have a similar affect, as certain industries are more restricted than others, so your initial investment can be "repriced" by Mr. Market to a permanently lower price multiple. This has to be carefully considered, especially since an industry's popularity can shift incredibly quickly.

Wrestling is ancient, but so is investing wisdom.

Wrestling is ancient, but so is investing wisdom.

Wrestling Concepts

Investing is all about measuring the struggle between opposing concepts. Aesop's simple fable, recounted by Buffett, is more than enough to explain the forces at play:

  • Opportunity cost means you're not so willing to give your cash (bird) up, unless you're getting much more in return, since you might need the cash for something else.
  • Inflation eats away at your cash, and this wrestles against the opportunity cost phenomenon.
  • Potential loss works from the same corner as opportunity cost, making it less desirable to invest cash, and the likelihood of partial or total loss should be taken into careful consideration.

By weighing all three of these factors, you can make a much more informed decision. Try to take all three into account with every stock or investment decision, and you'll run through a quick mental checklist that can operate as a quick screen, so you can identify which investments to look at under the microscope.

This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.

© 2022 Andrew Smith

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