So by this point, you’re probably wondering, “What the heck does that have to do with me?” Well, the interesting part of this story is how much EBay paid for the product that BEA spent millions to develop… $0! That’s right, not a single cent!

So why would BEA spend weeks negotiating a contract that nets them no money? Not only that, but there’s also the costs of supporting the product and continuing to develop it – all for free! Why, why, why would anyone do that?

Well, here’s what BEA got: EBay allowed them to tell other people that they (EBay) were using BEA’s product!!

A multi-million dollar product.

For free.

In exchange for being allowed to tell other people it’s being used!

Here’s a great example of how generosity yielded a company a lot of money. In fact, there’s actually two examples of generosity here!

Generosity From BEA’s Side

So why was it so worth it for BEA to let other people know that EBay is using its product? Well, because of the wide exposure of the EBay brand, people will have more trust towards BEA’s products if a large company like that is using them. This’ll allow BEA to sell more of its products to other customers, more than making up the costs of giving EBay a free license and support!

By being generous with EBay, BEA has put itself in a position to attract many more potential deals.

Generosity From EBay’s Side

On the other side, EBay’s branding is a perfect example of how generosity pays off! By being a company of integrity and trust, it’d established itself as a company that’ll go the extra mile to please its customers. By being generous with its time and effort, EBay has gained the trust of the consumer base. When you hear about an EBay product, you know it’ll be innovative and well done!

As a result, precisely because of this trust gained through hard work and a generosity of effort, companies like BEA throw themselves at Ebay in order to work with them!

Isn’t it nice to have two or more competing companies throwing their products at you hoping you’ll pick them to satisfy your needs? Not only that, but they’re doing it eagerly, and for free!

That’s what generosity does for you – it makes people really want to work with you!

And then you get to pick who you’d like to work with

An employeee-employer relationship is a common example of this as your salary as an employee is generally fixed. You don’t really get appreciated for taking a smaller salary, so the way that you can be a 40-60 person is to do more than a person in your position is expected to!

What You Can Do At Work

Here’s a few ways you can accomplish that at work:

Produce more than your position demands – Your number one purpose when hired is to accomplish a certain task. Therefore, try to be more efficient and accomplish more in the time that you have. If there’s some extra time at work when you’ve done your assignments, take some initiative and ask for more work! Aggressively seek things that nobody else wants to do but definitely needs to be done. Seek ways to do things faster and better.

Produce a better quality product – On the same note, if no extra work is available immediately, you can use your extra time to produce a better product. If you are a software engineer, you can look over your code and make sure it’s bug free. If you are a construction worker, you can make sure the wall you put up is polished and clean looking as well as sturdy!

Offer other people your help – Of course, your time might be better spent investing into the relationships at work. After all, you might need other people’s help in the future. You can offer to help other people with their projects instead of sitting back and relaxing. It’s a way of doing more work, but doing it through other people!

Have a better attitude – You can also give more emotionally than a person in your position demands. Is there a nitty customer that drives everyone nuts? Maybe you can make the company more money by being calm with him and listening to his needs. Is there a coworker with a lot of problems? Smile, be patient with him, and help him solve his problems. The positive emotional energy generated is reward on its own!

Seek out new sources of information and improve yourself – When there really isn’t anything you can do or help with at that particular time, you can always try to improve yourself to prepare for the next task. Read articles and magazines regarding your field. Read some books on interacting better with people. Make it so that you can accomplish the same task you did this time in 1/2 the time next time around!

What You Get For Your Extra Efforts

By being generous and taking on more responsibility, you generate goodwill with your coworkers and more money for the company. The next time a raise opportunity comes around, who will your manager give more to – you, a person who did more than his fair share, or someone else who only did his “fair share” of work?

Also, when your manager moves on, who do you think will take over his responsibilities? A person who doesn’t know what’s going on and nobody really knows, or you, someone who everyone likes and does all the work?

By being generous, you put yourself in a position to take advantage of new opportunities – in this case, raises and promotions.

Hey, even if your company doesn’t appreciate your efforts, maybe a competitor will hear of you and give you the salary and position that you deserve!

The Problem

In the deal, we’d acquired a website but without the license, which we’d understood would come later. However, the seller, not quite understanding that the software on the website required a license, wasn’t aware of it as part of the deal. As a result, he didn’t have the license and didn’t want to buy a new one, leading to an unpleasant situation where we needed to collect $300 from a person who didn’t want to give it!

This is probably a relatively common situation that everyone experiences at some point in their lives! You lent money to a friend and he doesn’t want to pay you back. You did some extra work and the employer didn’t want to pay you extra. You bought a product online and didn’t get it. Learning to handle this situation better would be very beneficial since it happens so often!

What Happened

Normally, in these situations, we’d just forget about it and not really worry about it. Unfortunately, in this situation, the seller kept telling us that he would give us the license and that he’s working on it. We tried asking and there were always little progress that he’s somehow working on it. We set deadlines and they were just ignored. We tried settling it but that didn’t work either!

Finally, the seller just ignored us after continuously promising us that he’s not arguing and that he’ll do it!

How Generosity Would Have Helped

So in the above scenario of what actually happened, we expended a lot of effort and didn’t really get any results! Not only that, but it made the seller stop talking to us, preventing him from bringing us further deals.

Let’s consider a more generous approach though! Say when the seller asked us about it, we could have simply said that since he feels the licenses were not part of the deal, he doesn’t have to pay for them. What a difference that would have made!

Instead of an angry seller, we would have one that would be more open to our perspective and eager to do more deals with us. Since each deal is like $6000, $300 is only a small portion of the amount. And since we are buying websites at that price, we make a significant return on it!

Instead of trying to make him pay us $300, we could have allowed him some way to create $300 of value for us.

Not only would it have made us more money in the long run, it would have allowed us to keep him as a friend who’ll possibly sell us websites for the entire duration of his life! Isn’t that worth just a little more than $300 we didn’t get?

The Negotiations Situation

Imagine there are three research companies A, B, and C. Because they’re in such an important field, the government is giving them a grant, but it’s structured a bit strangely! The companies are presented with the being able to pick only one of the following options:

Company A+B = $600,000
Company A+C = $800,000
Company B+C = $1,000,000
Company A+B+C = $1,100,000

Pretend you are one of the companies, what is your strategy to maximize your returns?

A Company Value Analysis

Because the government grants contracts to each pair of companies, each company has a certain value in the government’s eyes:

Company A = $200,000
Company B = $400,000
Company C = $600,000

You can do a quick check to see that these add up to the totals for the contracts above!

Of course this means that any of the companies can work with any of the other companies and come to this theoretical value for the deal. For example, Company A can work with Company B or Company C to get their $200,000 fair share. Or, the three of them can work together and split the $100,000 difference somehow ($200k + $400k + $600k = $1.2 mil, which is $100k more than the $1.1 mil offered by the government!)

So what’s the deal that should result?

A Loop For The 50-50 People

This is an interesting situation that presents a loop to the 50-50 people, assuming that everyone is going for these theoretical company values. Company A can offer Company B $400,001 and only take $199,999 to try to get the deal. However, Company C can in turn offer Company A $200,001 while Company C takes $599,999. Knowing that offer though, Company B might offer Company C $600,001 while Company B takes $399,999. But then Company A can….

This situation just never made sense to me in college. Wouldn’t the loop just go on forever and ever?

As I asked this question, the results for the class came in and a variety of deals developed. Some with Company A taking $150,000 and Company B taking $450,000. Some with Company B taking $380,000 and Company C taking $620,000. Some with Company A taking $210,000 and Company B taking $390,000. It all seemed so random!

The part that just kept bugging me was, why would Company B choose to take $390,000 when Company C is probably offering him $400,001? Wouldn’t it make sense to switch over to Company C’s deal?

Think about the situation for a second… what would you do?

How The Solution Makes Sense In The Context Of Generosity

After an hour or so of talking with the professor and my classmates, the answer to the burning question of “What does Company B get in exchange for that $10,001 difference?” finally emerged. It is… the deal! That’s right – by taking $10,001 less, Company B was able to secure the deal!

For some people, they’d probably much prefer to be in the situation where Company B took $450,000 and Company A took $150,000. However, in the long run, it might actually be better to be taking the $390,000! By taking $390,000 as opposed to going for the $450,000, Company B significantly increases the chance of getting the deal! Besides, life is a series of such “free” pies that are created. That $10,001 can bring a lot more of those!

Even from the perspective of the deal at hand though, by getting a deal, Company B gets $390,000 extra. By losing the deal, it gets nothing. It only needs to increase its chance of getting the deal by 1/400 in order for that $10,001 “loss” to be justified! This is not to mention the goodwill Company B would get from Company A by giving that $10,001. If such a situation arises again in the future, Company A might just go straight to Company B and not even talk to Company C! That’s what generosity does for you!

However, do note that this tradeoff does level off at some point. For example, if Company B only took $10, either the other companies would pretty much accept immediately. In this case though, it’ll need a lot more deals to make up for the $399,990 it missed out on!

This is not to say that’s necessarily a bad choice, as maybe it knows that there’ll be a $10,000,000 grant next year that it’ll need the goodwill of the other company.

Either way though, the main take away is that less than $200k/$400k/$600k may be the optimal choice for each of the respective companies!

The Solution When Everyone’s Generous

There is that special option where all three companies get some money though. However, it requires that the three companies each give up something and not get their “full” amount. It is a perfect example of how everyone benefits if they are generous! If each of the company is slightly more generous than 50-50, then they’ll all feel great accepting that slight loss so that everyone can be happy!

In the end, if they all cooperate and give a little extra, they get a bigger pie to share. If they do not, then they’ll have to fight over a smaller pie and one of them gets nothing! Not a bad reward for cooperating right?

A Situation To Test Your Generosity

Imagine yourself in a business venture with a friend. It’s new, it’s innovative, and you’re just completely excited! As a result, the business does really well and makes you a ton of money! Now suppose your friend gives you a blank check and asks you to split that money any way you want. That’s right – you get to pick your share and his share!

In glee, your first thought is probably whether you should take all the money. After all, he asked you to do it! If he’s willing to give it, why not take it right? Hmmm… but maybe he would be pissed off and force you to give a fair share…

Maybe you can take a little more than 50%, an amount that he barely cares about and wouldn’t really argue over. Perhaps 52%? He’s not going to give you crap for taking an extra 2% right? And with that 2%, maybe you can buy an engagement ring for your girlfriend…

On the other hand, he is your friend, so maybe you should give him his fair share. Being what you feel is very generous, you graciously decide to make it 50-50. Whew… he gave you a chance to be greedy, but you resisted! Good job!

Now, what if I told you that it might be better if you only took 40%?

Say WHAT??? Take less than 50%? Maybe you think I made a typo.

No really, take 40%. You’ll most likely make more money.

Yes, make more money.

The Nature Of Wealth

It doesn’t seem to make any sense on the surface. Let’s say the business made a million dollars. 60% of it is $600,000. 40% of it is $400,000. $600,000 is greater than $400,000. So how are you making more money by taking $400,000? Like, what?

Before going into the reasoning for that, let’s take a look at the nature of wealth in general.

Let’s assume Person A has some corn, and Person B has some apples. Person A got sick of eating his corn and wants some apples and Person B is in the same situation with apples and wants some corn. A field of apples is worth $1000 to Person B but $2000 to Person A. A field of corn is worth $1000 to Person A and $2000 to Person B. Therefore, Person B gives Person A some apples and Person A gives Person B some corn. They both become happier (see Do You Get Money?).

Before trading, Person A has a field of corn worth $1000 to him and Person B has a field of apples worth $1000 to him. Total wealth: $2000.

After trading, Person B has a field of corn worth $2000 and Person A has a field of apples worth $2000. Total wealth: $4000.

By trading, $2000 of wealth is created out of thin air.

This is also what happens when two people work together. One person brings a certain skill set, and another person brings a different skill set. Together, they accomplish things that neither of them could have alone. As a result, while Person A alone can make say $1000 and Person B alone can make $1000, together they might be able to make $3000 having expended the same amount of effort (see How To Get Your Partner To Do More Work).

So the real question here is how to divide up that extra $1000 of value created through both people. So 50-50 right? Doesn’t that sound really fair? Well, here’s why taking $400 might be better than taking $500.

How Being More Generous Makes You More Money

Assume for a moment that you are now the partner of the person and he took 60-100% of the money. How would you feel about it? Wouldn’t it feel kind of like he screwed you over? Wouldn’t you want to look for someone else who can maybe be happy with 50-50? Or god forbid give you a little more? How would you react the next time this person wants to work with you?

By taking more than your fair share of the money, you make other people annoyed. They despise you. They think you’re petty. They want to get as far away from you as possible. Sure, you got your extra 10-20% this time, but who’d ever want to work with you again?

Now, let’s say he picked 50-50, which is probably what most of the world runs on. “Not bad!” you think, “that’ only fair!” If you find a good deal again though, you’ll probably shop around see who’ll do the most work for their 50% cut. Hey, plenty of 50-50 people out there right?

Now, what if your partner offered you 60% of the money? Boy would you be eager to jump on board and start working hard! After all, you’re getting a bigger part of the pie! Would there be any question of who you’d want to work with?

Think about this for a second… how many 50-50, or even say 55-45 people, are there? Doesn’t that describe most of the world?

And who would they want to work with? Other 50-50 people, or you, a hard working 40-60 person? If word got out that you’re a generous person who’ll give other people more than their fair share, you can expect all those people to come knocking at your door!

With so many more offers to chose from, isn’t it more likely that you’ll find a better opportunity? 40% of a $1 million dollar opportunity is certainly much more than 60% of a $100,000 opportunity! Oh, so is 40% of 100 different $100,000 opportunities!

What you trade off as a smaller portion of a deal is greatly made up by more deals and better deals.

In this way, not only are you wealthier in money, you’ll also be much wealthier in friends!

The more I think about this concept, the more important and astounding it is to me. So many events in my life that didn’t make any sense now suddenly does. It resonates with me strongly both emotionally and logically!

To better understand this concept and spread it to other people, I will write an article once a day for the next 30 days to demonstrate this idea in action!

Getting What You Want

In How To Win Someone’s Heart, we looked at ways to secure the loyalty and trust of our fellow human beings. In this article, we’ll see how this concept applies more generally and from a more logical perspective.

Okay! We’ll get right down to it. Let’s say you’re walking around and there’s this person with something you want. Maybe it’s the $100 bill in his pocket, or maybe you want to have sex with her, or maybe you want him to vote for you. So how do you go about getting that person to give you what you want?

Well, let’s take a look at your options. You can either use force or not use force.

Option 1: Force The Other Person To Give You What You Want

In the case of the $100 bill, you would run up to the guy and rob him. In the case of the girl, you would rape her. In the case of the voting, maybe you would put a gun to the guy’s back and shoot him if he doesn’t vote for you. This is probably the most direct and the quickest way to get the object of your desire. And actually, it does work. You’ve gotten exactly what you want from this person. So what’s the problem?

Well, the problem is that you are also getting something you don’t want along with it! The guy you took the $100 bill from would probably want to kick your ass if he ever saw you again. The girl you raped would probably have you arrested and put behind bars for good. The guy who you forced to vote for you would probably kill you if he ever got a chance. That’s what happens when you take something from someone – they lose it and aren’t happy about that loss!

Beyond these problems, what are the chances of that person giving you what you want again? Do you think that guy would walk around with $100 bills sticking out of his pocket again? He probably doesn’t carry around more than $5 anymore! And that girl you raped – she probably got a big bad boyfriend named Bubba who’ll smash your head in. And that guy you put a gun to – he’s probably a black belt in some sort of martial art now and can probably take your gun and shoot you before you can say “vote for me!”

Forcing it does get you want you want, but at a very high price! It might be worth it if you are in a really desperate situation. Maybe you’re starving and need that $100 bill to buy your family food, or you are the last man on earth and that girl won’t have sex with you.

Just be aware of the price you are paying if you pick this option – it’s a one time thing, the other person will hate you and oppose you at any opportunity in the future. Whatever it is, it’d better be pretty damn important!

Is there a better way?

Option 2: Give The Other Person What They Want

Now, let’s say you are the guy with the $100 bill. A guy walks up to you and gives you a big diamond and he says, “I would really appreciate it if you could give me that $100 bill!” Wouldn’t you be much more likely to give it to him gladly? And the next time you have a $100 bill, wouldn’t you go around looking for him to see what he has to offer you?

That’s what happens when you give other people what they want! They’ll come back time and time again looking for that thing, and giving you more of what you want!

Of course, if you’re mean to them and laugh at them or something, then you’ll also be offering something they don’t want. As a result, they might go find someone else to get their needs fulfilled. For example, if you have an expensive jewelry store and you look down on a guy who comes in without a suit, that guy will probably go to another jewelry store even if you are offering better prices! Or if you give your spouse money and make them feeling like they owes you something, then they will probably go out to make their own money so that they can get away from you!

However, if you not only give it to them but you do it cheerfully, is there any reason why they would go to anyone else? When you become an indispensible source that fulfills other people’s needs, they will do whatever they can to keep you happy!

And therein likes the way to get what you want – Give other people what they want, make yourself indispensable to them, do it cheerfully, and they’ll come back again and again with what you want!

That’s a difference of 20 fold, and is one of the key reasons why you should start saving money today. As you read this, you’re probably thinking, “Wow! I’d better learn to invest in stocks better!” That 7% could be the difference between a $50,000 retirement fund and a $1 million dollar retirement fund in 50 years!

Awesome! Enthusiastically, you start learning about all the ways to value a company. Price over earnings ratio low, good! No debt – good! High ROE – great! On and on you learn, about all kinds of dips and rises in technical analysis. Supply is low! Demand is high! It’s hit a 20 day support! It’s hit a 50 day peak! It all sounds like it makes sense at the time. You’ve learned an awesome system. It should work – right?

Except sometimes it doesn’t. Stocks that hit their 20 day lows fall further to hit their 50 day lows, then 100 day lows, then 200 day lows… whoops! All of a sudden, that infallible “system” seems like complete garbage! And it is – because you only had a vague idea why it works in the first place. When you don’t know where the money is coming from, it’s hard to know why it doesn’t come anymore!

Maybe you try again and again and eventually, you do succeed a bit and increased your average yearly earnings to 12%. You pat your self on the back and congratulate yourself. That is great! You’ll have $289,000 in 50 years! Yay! That’s over a 4 fold increase that you can enjoy in your retirement!

Wait.. before you celebrate though, think about you much you’ve actually made this year!! You have made an extra 4% on your $1000. That is a grand total of $40!! With those hundreds of hours you spent analyzing stocks and learning about them, you could’ve been working near minimum wage at $10/hour and still have made a few thousand extra dollars!

“But I’ve learned how to get better than market returns now!” you say, “Some years from now, all this hard work will pay off and I’ll get superior returns!” Well, let’s see just when this hard work actually pays off! Say you are holding a pretty decent job at $50/hour, and you spend 15 hours/week studying companies and analyzing stocks. That is a total of 780 hours per year, valued at $39,000! So in order to justify spending that time this year, you’ll need to have invested $975,000! You need almost a million dollars and a sure 4% increase to breakeven on the amount of time you spent on it!

That would mean an absolutely no risk 4% increase from the market returns (since the job holds about no risk). If you make less than 4% or even lose money, then the opportunity cost of your learning experience is even higher! Remember that this % is relative to the market index though. For example, if the market gained 15% this year and you only made 11%, then you’ve lost 4% relative the alternative of just investing in the market. In these situations, not only have you lost the $39,000 (for this year), you would also have lost $40 more (from the 4% loss on your $1000), and you would’ve lost the interest on the $39,040 compounded for the rest of your life (at 8%/year, that’s $1.8 million)! Consider very carefully whether the knowledge you’ve gained is worth that! Will you really make $1.8 million of value (50 years from now) from the current knowledge you’ve gained?

Isn’t it quite possible that what you’ve learned isn’t correct? Or what if you never gain enough capital ($975,000 is a decent chunk) to actually make the difference in returns significant? How would you get that money if you focused all your efforts on learning about the stock market? As mentioned in How To Learn To Make A Good Investment, how does anyone know their skills are beating the market without having enough information?

With all of these uncertainties in the future and regarding the value of the skills learned, it’s exceptionally hard to value the knowledge you gain from spending that much time learning about stocks!

In these situations, it seems to make more sense to just focus more on the short term. Ask yourself, “Will I gain more this year (or over the next few years) by learning about stocks or just improving my skills/working hard?” Without capital near a few million dollars (and probably even then), it seems wiser to just build your business or career!

1) “Man, I don’t have a damn clue what this business does, but the numbers look okay!”
2) “Hmmm, can’t buy this stock because its [insert appropriate variable here] is too high!”

Now let me ask you, why are you buying / not buying this stock? Because the various financial variables indicate it’s under-priced? “It’s under-priced in a market that is expanding”, you proudly say, after analyzing about 43 different variables. Except over the next 6 months, the stock keeps getting more “under-priced” until you can’t stand it any longer and sell it at an even lower price!

What just went wrong here? Well, how do you know a stock is under-priced? In both of the scenarios above, the most important statement is I don’t have a damn clue what this business does! If you don’t know precisely how the business works, who their customers are, what value they are creating, and what the plans for it are, how do you know it’s under-priced?! Maybe it’s a company with a lot of potential; maybe it’s seasonal; maybe it’s being sued and about to go bankrupt. All of these and a million other things can create a stock with an “under-priced” or “ridiculously high” P/E.

The truth of the matter is, as an average person who hasn’t run that exact business before, you really don’t have much of a clue how it works! Let’s take a look at a best case example. Say you are a software engineer looking into investing in Google. Maybe you have a PhD in computer science and even know most of the search engine algorithms. Yet, even knowing all that, it’s still hard to grasp what Google is up to. You may know how some of the projects work, but isn’t the whole point to come up with new algorithms for things? How will you keep up with that? If you don’t, how can you know what the potential of those innovations are worth?

There are so many departments and so many projects. There are so many customers that are constantly changing. There are so many innovative new ideas floating around. You, as an outsider, can only really know the small 1 millionth of the information that the company broadcasts to you!

Can you find out about the enthusiasm of the people reporting to the CEOs?
Often times, the enthusiasm and drive of the people on the top are a big determining factor of how the culture of the company operates. What you see of the CEOs are the rare glimpses where they put on a mask for a public performance. How do they actually feel about their prospects? How do they really see the potential of the company?

Can you know what new plans for expansion are hatching in their minds?
As a business owner myself, my plans for the direction of the company isn’t always crystal clear. Sometimes, I just know the year is going to be good, based on my intuition and feelings which isn’t easy to logically express. There is no simple way to see things the way CEOs do, without being around them a large portion of the time.

Can you really know what the risks are without completely understanding what is being done?
Not knowing what the leaders of the company are really planning and thinking, nor the value of the innovations they make, can you really understand what is happening? It’s a common occurrence that something that makes no sense one way can suddenly make sense with extra information available. Maybe they redeployed certain resources to aim at a certain market they haven’t disclosed yet. Maybe they see that their potential customers aren’t trustworthy and that’s why they decided to pull out. Without being in the driving seat, most of the important information is simply missing! How do you calculate the risks of something with less than say 1% of the important information?

“Hey!” you might say, “I have all these ways I can get this information, etc., etc.” That is definately true! With sufficient time and resources, you might actually be able to gather most of that information… except in that case, you would (or at least could) be the person in charge! In order to truly understand another person, you have to be able to think the way he thinks. If you can do that, then you would have the skills to run the company! So unless you believe you have the capabilities of doing just that, your study of the numbers and risk factors really means next to nothing.

Therefore, if you are going to invest in companies (stocks are just a way of representing them) that you can run, then wouldn’t it make sense for you to just run them? It cuts out all the legal mumbo jumbo in the middle and extra expenses associated with a public image. Sure, you might get so good at it eventually that you can get someone else to run them (like Warren Buffet), but you can only gain that experience through actually having run a business and succeed in it!

So if you really want to become a good investor, start your own business and invest in yourself! See things as the CEOs see them. Only then can you truly understand what those financial “variables” really mean!

Recently, in my Stanford decision analysis class, I figured out how much part of my life is worth – about $500 million! Follow these steps and figure out how much you think your life is worth!

1) We’ll start by assuming that you are diagnosed with some disease. So umm… you’re dying! Good news though! There’s a cure! Bad news is – it’s an operation that requires a week of horrible pain. Ouch!

2) There’s more good news! Some guy who has undergone this horribly painful operation has made a painless cure. Yay! Unfortunately, he wants money for all his efforts in making it. Boo! Sooo, how much would you pay to avoid the week of intense pain?

3) Luckily, the government has taken pity on all the poor people. They made their own painless cure and are distributing it for free! It doesn’t work as well as the other one though… There’s um… a chance that you might accidentally die with this option! What chance of dying would you take to avoid that week of pain?

That’s all there is to it! Since you are indifferent between options 1 and 2, as well as options 1 and 3, you are indifferent between options 2 and 3. Therefore, the amount of money you paid in option 2 is how much you value the chance of dying that you specified in option 3!

If you divide the amount in option 2 by your chance of dying in option 3, then you get the $$/death (dollar amount that you would pay to avoid 100% chance of dying) – that is, the value of your life! This # came out to $500 million for me because I’d picked $500 for option 2 and 1 in a million for option 3.

Now, you probably have some objections! “Hey, I’m not willing to take any amount of money to die”, you’re probably saying. Yes, of course, I wouldn’t either This is because while I would take $500 for a 1 in a million chance of dying, I wouldn’t take $50 million for a 1 in 10 chance of dying. It doesn’t quite scale that way!

Here’s a typical chart:

For most people, the scale is quite linear until you get to about a 10% chance of dying. At that point, the marginal utility of your money (the amount you gain by trading parts of your life away) starts decreasing dramatically since money is pretty useless when you’re not alive to use it! The cost of trading away each additional % of your life increases exponentially.

However, because the scale is linear for a long part, it is still a quite useful measure. If you divide your total life amount by a million, then you get the amount that you would pay to avoid a 1 in a million chance of dying.

This becomes very interesting if you try to factor it into your every day activities. For example, a plane ride incurs approximately a 7 in a million chance of dying. So, technically, since I am willing to pay $500 to avoid a 1 in a million chance of dying, a plane ride actually costs me $3500 + the plane ticket price. Of course, this assumes that I have no chance of dying doing the alternate activity (such as sitting around on a computer typing this article).

This amount seems quite large to me though. If the plane ticket is $300, I don’t think I’m really willing to pay $3800 to take that same flight with no risk of death. It would appear that I have a very poor perception of the riskiness of certain activities and how much that risk is worth to me. Perhaps, in the example above, I really am willing to take more of a 1 in 100,000 chance of dying or 1 in 10,000 chance of dying. In that case, I’d pay $35-$350 for extra safety, which would be well worth it.

How much is each portion of your life worth? Are you sure?

The PE Ratio

If you’ve ever tried investing in stocks, this is probably the first number people mention. If you pull up any ticker, like MSFT, you’ll see this number:

So what is it?

What Is The PE Ratio

On the surface, the P/E ratio is how much the company is currently worth on the market, divided by the amount it made last year. For example, if the stock was $20/share, and the company made $1/share, then it has a P/E ratio of 20. Or, if you take another perspective, if the same company has a market capitalization of $2 billion and made $100 million last year, that’s still a P/E of 20.

So formula wise PE ratio = Current Price Per Share/Earnings Per Share
= Current Market Capitalization/Earnings For The Company For The Year

So all that is good, but now you have a number like 20. What does it mean though?

What The P/E Ratio Means

Most people would just take that number from each company and just start comparing it to other companies. They’ll say like “Oh, this company has a P/E of 5, and this one a P/E of 20, so the one with the P/E of 5 is cheaper!” That’s actually not really true, and we’ll see why when we look at what that number actually means!

Let’s take a realistic example to put things into perspective:

Let’s say you decided to invest $1200 into an arcade business. The model of the business is that you put arcade machines in shops, and collect the money once in a while when it’s full. Luckily, you have an uncle who owns a barbershop, so he lets you put it there for free. While people are waiting in line to get their haircuts, they put in money to play your arcade machine. Every once in a while, you empty out the money. Consider the following scenarios:

You empty it out once a year and finds that it makes $600 on average. In this case the price you bought the business at ($1200) divided by the earnings of the business every year ($600) is 2. So in this case, your P/E is 2 – 2 years. This means that if the business continues making the same amount of money as it does now, you’ll get your money back in 2 years.

You empty it out once a month and finds that it makes $50 on average. In this case, you’re making the same amount of money per year ($600), so your P/E is still 2 years! However, if you did price ($1200) divided by earnings per month ($50), you’d get a P/E of 24. That 24 is 24 months though! It’s saying at the current rate of $50/month, it’ll take you 24 months to get your money back.

You have a partner, who invested in this business with you, so you both contribute $600 and get one share of the company. In this case, the yearly earnings of the “company” would still be $600, but since there’s two shares, the earnings per share is $300. Since the price of your original share is $600, the price per share ($600) divided by the earnings per year per share ($300), so the P/E is still 2 years.

Price Earings Ratio Considerations

- Remember the units of the price earnings ratio. When it’s listed, it’s normally in years, meaning the number of years to get your money back assuming nothing changes. However, when dealing with a low or fractional P/E, it might be useful to talk about P/E in terms of the # of months.

- Things can change, which is why there are other figures like the forward P/E (price divided by how much the company expects to make the next year). It’s also why the P/E can vary greatly depending on how much it’s expected to grow or decline. For example, a company about to go bankrupt may have a P/E of 0.05, while a company expected to grow a lot can have a P/E of 100. Just remember that the P/E number listed reflects price / last year’s earnings.

- In our example above, we didn’t figure in taxes, so if you had to pay tax on that $600 you make every year, the P/E would go down. Mainly, just pay attention to what the earnings # is. In this case, you can separate it out into a pre-tax P/E and a post-tax P/E.