The Farmer’s Fable: Free as in Lunch
Today, I’d like to tell you a little story about a farmer named Bill. If you’re not into farming, it just so happens that Bill discovers one of the most important principles in investing and decision-making in this story, so there’s also that.
Anyway, back to Bill. Bill grows crops. In a good season, Bill harvests 150 seeds for every 100 seeds that he plants. That’s a 50% growth rate!
If Bill does that every year, his farming business will grow exponentially. 1 kilogram of seeds grows into 1.5kg of seeds in the first year. 1.5kg of seeds grows into 2.25kg of seeds the next year, then into 3.375kg of seeds the next year, and so on.
However, farming is not so easy a business. Some times, Bill has bad harvests. In bad years, he only gets 70% of his seeds back, a loss of 30%. For Bill, good and bad seasons are equally likely and unpredictable. On average, half the years will be good and half will be bad. But, it’s possible to get “lucky” and have a streak of good years or “unlucky” and have a streak of bad years.
That’s not ideal as a smooth exponential growth curve, but it still seems pretty good, right? It’s a positive expected value bet: half the time you make 50% and the other half the time, you lose 30%. On “average,” you make 10%.
