Pimp my life!

From CNN Finance, we have an unusual kind of article: College kid tries to sell his future on eBay.

In August, Steen put himself on eBay (Charts) to pay for his college education, offering 2 percent of all future earnings to the highest bidder, with a minimum $100,000 bid.

"I am the real deal" and "a very intelligent guy," he wrote on eBay.

He says that he expects to earn "way more" than $125,000 a year until he turns 65, at which point his investor would break even on a $100,000 investment. (Steen would have to average more than $1.5 million a year to match an investment that yielded a 6 percent return, compounded annually over the same period.)

Here's a link to the PDF of the actual auction. (EBay cancelled the auction, and he got no bids.)

Firstly, I should say flat out that this is, in principle, an excellent idea. After all, exchanging future income for a lump-sum up front is precisely what a bond really is.

Secondly, if enough people did this, you could statistically estimate their future earnings, and price them competitively. (Think of it as an insurance policy on education. The future "investment bankers" are subsidizing the future "secretaries", etc.)

So why is it really stupid?

Several reasons.

Firstly, let's examine the reasons as to what can go wrong. Perhaps, he will renege on the contract, die or get dismembered before 40 years, or simply not make as much money as he thinks he's going to make.

Now let's work through these assumptions. We'll do all the calculations in "future dollars" so we have to include the effects of inflation. If he's really good at what he does, his wages will be above inflation each year by let's say 1-2%. Let's also assume he makes $100K (highly unlikely, but still.) Let's assume inflation runs at a fixed 3%.

You'd get paid between $190K (4% assumption) to $240K (6%).

Take the same $100K and buy 30 year US treasuries, and you'll get roughly $138K of coupons at current yields, plus your original $100K back, plus any interest that you pick up by reinvesting these coupons! Add in interest for an extra 10 years (at the same rate) you get an extra $46K. (That's $284K.)

So this kid is shit out of luck even under the most optimistic assumptions. You don't have to be a genius to figure out if you assume more realistic assumptions, you'd be really stupid to invest in this kid.

I mean, if the kid can't even do these calculations, there's no chance of him making "way more" than $125K.

So what did he really do wrong, theoretically speaking? Obviously, 2% of your income is too little. Up it to 10%, and the numbers would change.

The other alternative would've been not to demand a minimum of $100K, but let the market determine what they're willing to risk on you.

(Incidentally, Robert Shiller has written extensively about this in his book: The New Financial Order.)