One of the essential challenges in life is understanding the difference between money received and value created.
Knowing how much money you get paid is relatively straight forward. You generally know how much you get paid.
Value is a much trickier concept. While value creation should imply an expectation of money being received (or less needing to be paid), there can be a significant time gap between the two, as well as an uncertainty as to when and how much will be received (and indeed, in some cases you may not receive any). And there is no necessity that the money or saving will come to you – intentionally or unintentionally, others might get some or all of the benefit.
Unfortunately, humans have a tendency, when faced with a difficult problem, to subconsciously replace it with a much easier problem. A lot of people intend to largely optimise for value created. And if you optimise for money when you actually mean to optimise for value created, you’ll be making the wrong decisions.
Obviously, it isn’t unreasonable to at least make sure you are paid enough to survive. And someone might actually want to maximise the amount they get paid in a particular period, or ensuring that all, or as much as possible, of the value will lead to them benefitting. But if you’re doing that, it should be a conscious decision.
There are a number of causes of difference between valuation creation and money you get paid:
- Investing in your future, or borrowing from the future
- Collecting on past investments, or paying back past debts
- Taking from others
- Giving to others
- Luck (for example, a lottery ticket paying out, or not)
It isn’t always obvious when these are occurring, and people often subconsciously misinterpret them – for example, convincing themselves they have created value when really they were just taking from others or borrowing from the future. Taking an honest view in distinguishing takes real effort, but it is crucial in order to make the right decisions.
I’ve read a few more books since my last post on the subject.
Other People’s Money, by John Kay, came recommended by one of my colleagues, and I found it excellent. The book takes a good look at the banking and finance industry, and how changes in the industry over the past 30 years made the global financial crisis inevitable. Personality driven stories like ‘The Big Short’ make for better movies, and are certainly worth reading/watching, but they can give the false impression that the problems are caused by extraordinary criminals, or bizarre anomalies in the market, and the solution is more regulation.
In fact, as this book outlines, the problems are far more endemic and a result of a number of gradual shifts over the past 30 years:
- Longer chains between capital user and capital lender/investor, making the overall system less stable, and reducing the involved parties’ knowledge of the fundamental needs/abilities of the ultimate lender/investor.
- An increased appetite for profit (including ‘apparent’ profit) and a disdain for boring respectability; banks optimising their business model to take advantage of the public’s trust in them.
- The increasingly unquestioned assumption by parties (including regulators and governments) that more trading was always good for society, and a corresponding inability to distinguish between genuinely value-creating trades and those that merely passed risk onto someone unable to value/manage it.
- Banks devoting far more of their resource to trading with other financial organisations, rather than supporting commercial and residential customers.
The book successfully steers clear of oversimplification, and is full of valuable insight, whether or not you work in banking: not only do we all depend on an effective banking system, but the lessons in this book have a lot to teach other industries.
The other main book that I read that I’d recommend was Red Notice, by Michael Brewer, about his adventures (and eventual misadventure) investing in Russia. It was as well-written as any spy thriller, but hard-hitting because it is a true story – it is a book that I’m not going to forget in a rush.