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Published in 2009 by John Wiley & Sons (Asia) Pte. Ltd.
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Library of Congress Cataloging-in-Publication Data
ISBN: 9780-470-822395
Typeset in 10/13pt JansonText-Roman by Thomson Digital
10 9 8 7 6 5 4 3 2 1
This book is dedicated to my parents, Peter and Amy and my husband, Vincent
PART I
PERSONAL
1
HOW MONEY WORKS
GETTING A GOOD JOB IS A DUMB IDEA
Most parents and teachers would tell you: Study hard in school, get a good job, receive a good salary, and live happily ever after. In fact, when I was a senior at Stanford, the only thing my friends could talk about was how to get a good job at a consulting firm or at an investment bank.
There is nothing wrong with getting a good job if you just want a stable life. A good job, by definition, pays well and has good career advancement opportunities. You will save up and eventually will be able to buy a nice place to live in, own a car, and send your kids to school. Although you will most likely always have to be careful with your expenditure to make sure you can pay the mortgage and the school bills, you will still be somewhat comfortable. You will most likely be in the good solid middle or slightly upper middle class.
However, to most Harvard Business School (HBS) students, getting a good job is a means, not an end. HBS students do not think of getting a good job as the ultimate goal for several reasons:
a. If maximizing wealth is your ultimate goal, then salary is not the most efficient source of income.
HBS teaches you to differentiate between two types of income: linear and investment. Linear income depends on how much time you put in. In a way, it is selling your time at a certain price per unit of time. Salary is a linear income. You put in one month and you get paid for that one month. No more, no less. The more valuable your time is because of your experience, competence, or tenure, the more you get paid per unit of time. But you stop getting paid the moment you stop work.
Investment income, on the other hand, does not depend on how much time you put in. You invest money (and maybe also some time to do due diligence and some follow-up) and you get continuous payoffs. Your income is not directly correlated with how much time you put in. The payoff is not a result of selling your time. Rental income, stock dividends, book royalties, and savings account interest, for example, are investment income streams. You put in money (and maybe some time) in the beginning and then you receive an income year after year. (Now a small test question: If you buy a small fruit shop and stand there selling fruit 12 hours a day, is your monthly income linear or is it an investment income? The answer is linear, because even though you are not working for a salary, If you stop working tomorrow, the fruit stand will have to cease business. But if you invest in the fruit stand and hire someone else to manage it while you just monitor the results as you see fit and pocket the profits, it is investment income).
Linear income is far inferior to investment income. After all, you stop generating linear income if you stop work. Linear income therefore is more risky. Also, you have only 24 hours a day. There is a limit to how much time you can put into your work. In fact, the secret of wealthy people is not only that they have more money but they also have more free time to enjoy life. Looking at wealth this way, many professionals are really not as wealthy as they appear. Doctors and dentists do not earn investment income from their profession. They have to keep seeing patients to earn money. If they take a year off, they have no income from their practice for the year. Also, the income level from their practice is more or less capped. There are only that many days a year and they can only see that many patients a day.
Of course, some jobs (such as major corporations, partnerships, or start-ups) give you stock options or outright grants of stock. This will mean your job now could generate investment income in addition to linear income. This is marvelous, but it should be noted that in major established corporations, employees have to be quite senior to get significant stock options. You may be able to get more stock options from start-ups. For example, I once met a wealthy HBS alumnus, and this was his story:
I was one of the earlier employees of a start-up back in the late 1980s. It was very small when I was there. I got some stock options but I did not think much of them as I was not very senior and the value did not seem much. Then I left the company. After the company got listed some years later, I would check the newspaper once in a full moon on the stock price. For years, it always seemed to be about the same level every time I looked. So I would sigh and not pay attention. One day I decided to sell the shares as they were not going anywhere. It was then that I found out the company had had many stock splits over the years and my stocks were worth a lot of money.
Unfortunately, start-ups give more stock options because they have a high risk of failure. When the start-up fails, its stock options will be worth nothing.
b. If financial security is your ultimate goal, then working as an employee is risky.
You can lose your job, even when you are performing very well. Poor economy, strong competition, office politics, and a dozen other factors can make you lose your job. Even blue chip companies often have to lay off good performers as well as bad during economic downturns. In The Millionaire Mind, Thomas J. Stanley reports surveying 733 millionaires in the United States and finding that most of these millionaires worked for themselves. Paraphrasing and combining the thoughts of several of these millionaires, the author describes how the millionaires responded to the idea of safety and security in working for a salary rather than for themselves:
(Working for the others) may actually put you at greater risk... Having a single source of income... not being given the opportunity to learn how to make thousands of decisions... decisions you would have mastered if you were self-employed... you are not doing things that are in your own best (economic) interest for you to become successful in terms of becoming wealthy.... You are merely doing what is in the best interest of an employer.
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