Warren Buffett’s Pinball Machines

Warren Buffett's pinball machine theory.

In Warren Buffett’s biography, The Snowball, I found an interesting story from when he was seventeen. He read about an idea of buying a used pinball machine and using the income generated by the first machine to buy additional used pinball machines.

So Warren bought a used pinball machine for $25 and went into the local barbershop to offer the owner a “no risk” proposition. He offered to put the nickel pinball machine in the barbershop so the customers could play while they waited for their haircut. He offered a win-win deal to the barbershop owner where they would split all of the money collected evenly. At this point in time, nobody had every tried putting a pinball machine in a barbershop, so they had no idea how it would do.

On the first night, Buffett’s pinball machine collected $4.00. Buffett’s pinball machine stayed and after the first week, Warren scooped the nickels into two piles for himself and the owner of the barbershop. Warren counted his pile and his share of the income collected was around $25. This was enough to buy another used pinball machine.

Pretty soon, seven or eight used pinball machines were sitting in barbershops all around Warren’s town. From the book:

“Warren had discovered the miracle of capital: money that works for its owner, as if it had a job of its own.”

This was a very important lesson for Warren because he could see “compounding” in action. The first pinball machine provided enough income to purchase the second pinball machine. This process continued into numerous pinball machines. Today, Buffett uses this exact same strategy with businesses. He buys a great businesses and then uses the income collected from the business to acquire additional businesses.

The challenge of compounding is in the beginning stages. The reason why is because Buffett couldn’t spend any of the income from the first pinball machine. He had to reinvest it into the second machine. Throughout this process, he had to work for free. He had to buy the machine, sell the barber on the deal, get it delivered and installed, handle maintenance and repairs, and he had to collect the coins from the machine.

This is basically the same process we go through with real estate investing.

We have to buy the property, handle any repairs or maintenance items, advertise the property, show the property, screen tenants, handle the lease for our new tenants. We have to work for free to create this income stream. And then, if we want to compound our wealth further, we have to reinvest the income collected into new income producing assets.

Truth be told, it isn’t a lot of fun.

This is because you feel like you’re working for free. You’ll be trading away some of your free time to create and manage this income stream that you’re not going to spend. Your quality of life won’t improve during this stage because you won’t be buying new car, or a bigger home. You’ll simply be working to build your snowball of wealth.

However, you can rest assured that a time will come when you’ll be rewarded for your hard work. If after buying his 8th pinball machine, Warren decided to stop reinvesting this income, he would enjoy $200 a week. His first $25 investment into the first used pinball machine blossomed into 8 machines paying him $25 a week.

We have this same opportunity today with real estate. What’s your equivalent of Buffett’s pinball machine?

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