We are notoriously bad at estimating the value of things in the future, especially in the distant future. Also: Anybody who's ever purchased an extended warranty should re-read this post twice.
Back in the 1800s when I was a wide-eyed finance student getting my MBA at Columbia University, we had a surprisingly cute economics professor who one day in class held up a check for $100. She told us that this check was dated one year in the future, and that she was selling this future-dated check to whichever student made the highest bid.
For a few minutes we all sat there in confused silence, until I broke the spell and bid ten bucks.
Soon afterward, several other students caught on and I was quickly outbid. The bidding went to $40, $50, $75, $85, $90, $95... and finally one guy in our class idiotically bid $99 cash for a $100 check that he might get next year.
I think that guy later went on to work in mortgage-backed securities.
Okay, what's the point? The point is that money paid in the future is worth a lot less than money in your hot little hands today. It should also go without saying that a mere promise to pay you money in the future is worth hella lot less.
All of this explains why the insurance industry--which is in the business of taking money from you today in exchange for a promise to pay you if you experience a loss in the distant future--is hilariously profitable.
And yet insurance seems like such a mathematical, quantitatively-driven product, doesn't it? "I'd like one million dollars in life insurance coverage. How much will it cost?" And the friendly agent checks the book, quotes you a price and helpfully offers you a whole suite of investment products that he can wrap around his policy. All of which are designed to help "protect" you from what is really a highly emotional situation... triggered by the fear of your own death.
An extended warranty is just another form of insurance. The product you buy--whether it's a DVD player, a car or a that brand new blimp you've always wanted--will have some form of warranty already offered by the manufacturers. After all, they want to at least try and convince you that their product isn't defective right out of the gate. So you might get a three-year warranty on your car automatically. But then the dealer wants to sell you extended warranty coverage. He wants to sell you protection that doesn't even begin until year 4. And he wants in exchange a lump sum payment now.
Did you know that extended warranties are among the most profitable products sold at Best Buy? That a good conversion rate for extended warranty sales can have an enormous impact on an auto dealer's profitability?
What does this imply about the value you get as the consumer on the other side of this trade?
If you are ever asked to enter into an exchange of your money today in return for a promise of some amount of money in the future, be very very careful. You are most likely egregiously overpaying.
That's why I only bid $10 for my cute professor's check.
Next up: Rationalization and Justification
How can I support Casual Kitchen?
If you enjoy reading Casual Kitchen, tell a friend and spread the word! You can also support me by purchasing items from Amazon.com via links on this site, or by linking to me or subscribing to my RSS feed. Finally, you can consider submitting this article, or any other article you particularly enjoyed here, to bookmarking sites like del.icio.us, digg or stumbleupon. Thank you for your support!