Risk and Reward, or how to make a lot of money
I remember the first time I learned about the true nature of reward in the real world. It was jarring and sudden, a feeling someone less cynical might call a paradigm shift.
From the time we’re first able to learn, society teaches us that reward is a function of effort. Work hard, and you’ll be rewarded. Study hard in school, and you’ll be able to go to a good college. Study hard in college and you’ll be able to land a job at a prestigious company. Work hard at your job, and you’ll get a promotion to a position that pays more. The world rewards hard work. The harder you work, the more money you make. The people that make the most money are the ones who work the hardest.
This, of course, is a monstrous lie.
Why do actors clowning for the camera a few hours a day make 1,000 times as much as teachers? They certainly don’t work 1,000 times harder.
This is generally considered a great injustice, a failure of free market capitalism.
But markets don’t have the capacity to be just or unjust. They just exist, indifferent to whatever the contemporary moral outrage may be.
People perceive stratospherically high salaries in feature films, professional sports and hedge funds as unfair because they’ve made the assumption, drilled into them by years of socialization, that reward is correlated by effort. .
But markets don’t reward hard work or effort. Let’s repeat that, for clarity:
The amount of money you make has nothing to do with how hard you work.
The market doesn’t care how much work you put into a product you’re selling.
What markets really reward is RISK.
Top film actors make millions because they undertook the incredibly risky decision to come to Hollywood and try to make it as an actor. The expected value of becoming an actor is actually quite low, and the chances of getting “discovered” and making it big are minute. In order to incentivize people considering becoming an actor, the rewards for making it big have to be incredibly high to compensate for the risk.
In any field where the people at the top make a lot of money, you’ll find thousands more striving for the top but making nothing.
More accurately, markets really reward perceived risk. The activities that people see as risky will always provide a proportionately high reward, even if the actual risk isn’t very high. For example, wildcatting for oil (drilling oil wells outside known oil fields) is currently very risky. You could spend a lot of money drilling only to find nothing. Of course, if you do hit oil, you’re rich.
Now imagine you invent a process for finding out exactly where every untapped oil reserve is. Wildcatting is no longer risky for you, because you know exactly where to drill. But you can still make a lot of money looking for oil because the process remains risky for everyone else.
Therefore, if your goal in life is to make a lot of money, you should calibrate your efforts towards two strategies:
- Finding ideas that are actually less risky than they seem.
- Identifying methods for de-risking a currently lucrative idea or career.
Startups are a great example of combining (1) and (2) for maximum probability of success.
Starting a startup, especially if you’re lucky enough to do it with OPM(Other People’s Money) is, in reality, a very low risk endeavor. And you can further de-risk the project and increase your chances of success by following best practices (cf. the Lean Startup movement) and systematically optimizing traditionally risky areas of business like customer acquisition.
But the perceived risk of quitting your stable, reliable job to strike out on your own and try an unproven business model remains very high. Thus, startups remain lucrative for those willing to think critically about perceived vs. actual risk.
And that’s how you can make a lot of money.