Why aren’t all economists rich? Some are. Economics is the most common degree amongst the world’s top 100 billionaires. Some famous economists such as David Ricardo and John Maynard Keynes were very wealthy indeed. However, for the most part, economists will give you a list of excuses why understanding economics won’t make you rich.
They are wrong.
How do I know this? I used my understanding of economics to become wealthy.
I won’t go into the (lame) excuses economists give. Instead, I will tell you how I used my understanding of economics to build my fortune.
Some of these topics could fill a book, so I’ll just cover the basics. I’ve already written articles about most of these topics.
The returns from re-investing profits from an investment are the single most important principle of personal finance.
This taught me a few things: (1) maximize my savings rate (2) invest while I’m young (3) time in the market is more important than timing the market.
Efficient market hypothesis:
The efficient market hypothesis (introduced by F.A. Hayek in 1945) is the idea that prices incorporate all public information about markets. This means that “buy low, sell high” is impossible using only public information.
This taught me:
- (1) Technical analysis/day trading is stupid
- (2) Don’t pick stocks (unless you can dedicate your career to it). Invest in broad-based index funds
- (3) Keep costs low. You can’t consistently generate superior returns, but you can maximize the return from the market by buying cheap ETF’s.
- (4) Maximize time in the market because you can’t time the market.
- (5) Consistent alpha generation requires non-public information
- (6) Don’t trust your money to an “expert.” They are unlikely to do any better than random.
Austrian business cycle theory (ABCT):
The Austrian business cycle theory (Ludwig von Mises, Theory of Money and Credit, 1912) explains how expansionary monetary policy leads to unsustainable investments (the boom), followed by a necessary correction (the bust). This has huge policy implications, but it’s also important for investors.
It taught me:
(1) Bull markets are headed for a correction when investments become unsustainable.
Signs of an upcoming correction may be:
high P/E ratios,
dumb projects getting funded, etc.
(2) Credit expansion (and associated inflationary policies) cannot be reversed. Don’t bet on fixed-return investments.
(3) All fiat regimes end lead to hyperinflation — so protect your assets from inflation. Stocks, precious metals, and Bitcoin provide protection from hyperinflation.
Modern portfolio theory (MPT):
MPT ( Harry Markowitz, “Portfolio Selection”, 1952) is a model to understand the relationship between investment risk and performance. Given a set of investment categories with a given risk and rate of return, you can graph all possible allocations of a set of investments on an efficient frontier: a hyperbola that represents a combination of investments that has the least risk for a given level of return.
It taught me:
(1) While you need to take more risks to get superior returns, you can get a free lunch if your risky investments are uncorrelated. Diversify your portfolio with non-correlated assets to maximize returns given a certain level of risk
(2) Lower your risk with a small allocation into safer assets with minimal impact on returns.
The capitalist-entrepreneur organizes capital and labor in new ways to make a profit. More generally, entrepreneurship is the activity of creatively organizing these elements to create value. (Ludwig von Mises, Human Action, 1949)
The reward for entrepreneurship is the profit the entrepreneur collects from the value he generates.
Everyone faces the decision to become a wage worker (employee) or entrepreneur. The upper end of the wages an employee collects is the value he creates for the business. The lower end is whatever another potential employee will offer for the same service — in other words, “what the market will bear.”
What this taught me:
No matter how much value I create for the business, my salary will always be limited to the market rates.
There are two ways to raise one’s income:
1: Redefine your job so that the pool of competitors is more exclusive.
2: Become an entrepreneur, so that your income is limited only by the value you create, not the prevailing wage.
In practice, I have done both in my life.
As an employee:
For example, I started my career as a software engineer. I then became a software architect, technology lead, director of marketing, then Chief Technology Architect. My strategy was guided by two questions:
1: how can I create more profit for the business and thus increase my value and
2: how can I limit the pool of competitors by working in a more exclusive role?
As an entrepreneur:
In contrast to employees, entrepreneurs can collect all the additional value they create (after expenses). Aside from a few exceptional careers (CEO, movie star, athlete, etc), entrepreneurship is the primary way to real wealth.
Ever since I discovered the role of entrepreneurship from the Austrian School of Economics, I’ve strived to engage in entrepreneurship even while I pursued my career. Currently, I do this as Managing Partner of Vellum Capital, a hedge fund specializing in cryptocurrencies.
Last word on Abundance:
Economics is all about the study of scarcity. Human beings have unlimited needs in a world with limited resources. The field of economics studies how to best allocate these limited resources to maximize human satisfaction.
But this focus on scarcity can lead us to miss another important lesson of economics. Value does not exist in nature but human beings. Human beings create value for themselves and others when they re-arrange capital and labor to produce goods and services.
While the elements of nature are finite, the potential value that humans can create is infinite. For example, some sand on the beach can provide momentary value when kids play with it. It can provide more lasting value when it is used to mix concrete for a building, or even more if the silicon is made into solar panels, or even more if the silicon is made into a million-dollar supercomputer. The combinations of labor and capital are infinite, and so is the value that they can create.
Economics is all about managing scarcity, but it teaches that the economy is not a fixed pie. Economic activity creates value rather than distributing it. The universe is full of opportunity, and we need only to develop an entrepreneurial eye for our small part of it, to learn how to profit from it.