Compound effort over time, part II: generations of wealth
One of the secrets to building true wealth is 'compound effort over time' - work hard at your chosen field, says Bill Bonner, and it'll pay off. But how do you go about building wealth that spans generations?
We recently discussed the real secret of success. As you knew all along, there is no secret. Hard work over a long period of time pays off just like compound interest does the job on your savings.
'Compound effort over time', is how we put it.
The longer and harder you work at something, generally, the more success you have.
But we left an intriguing idea dangling. What if you could work at something longer than a single lifespan? What if you could keep compounding for more than one generation? What if one generation could help the next succeed?
The idea is both self-evident and shocking. In America, you are supposed to be self-reliant, self-sufficient and independent. You should believe that you are responsible for your own success. You are supposed to be able to do whatever you want to do, and go as far as your luck and pluck permit.
What if it weren't true? What if your success in life depended largely on your parents and grandparents?
Driving across Baltimore recently we went through a working-class neighbourhood called Dundalk. Fifty years ago, it was a neighbourhood of white, blue-collar factory workers and their families. Men earned good wages at the GM plant, or at Bethlehem Steel, in the ship terminals, mills and factories. Women stayed home and raised their families.
And today? The factories are largely gone. Now, men work in lower-paying jobs in the service sector. Women are single mothers. But they're still in Dundalk.
We have no facts. Just observations and guesses. But fact-finders have already concluded that America has much less 'social mobility' than it used to have, even less even than Europe's sclerotic social-welfare states.
Why do people stay in Dundalk? Are they genetically programmed for the lower middle class? Are they culturally suited for low-skill, low-income employment? Are they educationally prepared for nothing else?
Sociologists argue over the causes. What interests us are the effects. For whatever reason, the next generation picks up where the last one left off.
We know that wealth is accumulated over many generations. We know that just by looking around. Our generation did not build many of the edifices we see, nor clear the fields where are crops are planted, nor invent the automobile, the aeroplane, the television or the toaster. We inherited those things, and much more besides.
We know too that if you're born in New York rather than New Delhi, you're likely to be richer. And we know that if you're born to a rich family in midtown Manhattan, you're likely to be richer as an adult than if you're born to a poor family in Harlem.
And yet, how many people take responsibility for their children's wealth? How many figure out how to compound their success into the next generation and beyond?
There are many things that take more than a single generation to accomplish. If you want mature oak trees lining your driveway, for example, you had better think in terms of generations, or start very early. Olive trees can take an entire generation 35 years before they produce a decent harvest. Then, they live for centuries longer.
And what about a skill or a reputation? How long does it take to build a reputation as a great beer-maker? A great winemaker? A great guitar-maker? Or a great banker?
Not years; generations.
The Martin family started making guitars in 1811. Now, everyone has heard of Martin guitars. The family is still making them.
The Beretta family is still making guns; the business was begun in 1526.
The Rothschilds have been in banking since the 18th century.
The Lemoine family started publishing books in Paris in 1772; they're still at it too. And the Hoshi family in Japan has been running a hotel for 1,200 years!
Of course, these are rare examples. But there are a lot of businesses that involve delicate judgments, unusual habits, or the kind of specialised knowledge that is very hard to come by in a single generation or learn in school.
Parents mortgage their houses to send their kids to school. But the parent who advises his child to stay in school or graduate school may be doing him a big disservice.
The common belief is that people who get advanced degrees earn more than people who don't. Statistically, this is true. But it is misleading. It doesn't mean that any individual who gets a degree or advanced degree will earn more than if he didn't. All it means it is that taking the whole population, average people who have more education tend to earn more than average people who have less education. Doctors earn more than carpenters. Engineers earn more than backhoe operators. But the average person earns an average salary. Obviously, if you want to earn an average salary you are better off in a field where the average is high.
But what about earnings that are not average? What about the fellow who was going to be a doctor and instead decides to start a business of his own, or goes to work for a pharmaceutical company? Would he be better off with more years of book learning or more years on the job?
To ask the question another way, would Bill Gates have had more success if he had stayed in Harvard and gone on to law school? We don't know. But it is unlikely.
To turn to a more common example, what about the child who is destined to enter the family firm? Is he better off spending more time in school or going right to work? Almost every parent would say "let him stay in school as long as possible". If pushed to identify the merits of further education, the parent would say "it can't hurt".
But maybe it can hurt.
People learn, no matter where they are and what they do. So, the real question is, where are they likely to learn more, or which kind of learning will be more valuable?
Book learning has a value especially in the sciences. But if the hypothesis of 'compound effort over time' is correct, it may be more valuable to begin early accumulating the instincts, experience and hunches that prove so valuable in real life.
Plus, time spent in school may not only be less productive, it may be counterproductive. Much of what is taught depending on the discipline is not knowledge at all. It is nothing more than intellectually fashionable claptrap which later proves to be completely false. Imagine the poor family that sends a child to an Ivy League school so that he may get a degree in economics or finance. Then, it sends him to a business school so he may deepen his understanding of the subject. By the time the kid finishes school, the family has spent nearly $300,000 on his education.
Then, when his studies are finally completed, he comes back and applies the latest theories of finance to the family fortune. Had he arrived on the scene in 2005-2007, for example, he might have loaded up the family with a portfolio of mortgaged-backed derivatives, in order to earn higher yields from 'safe' investments.
He might have applied 'modern portfolio theory' too, like the geniuses running Harvard's endowment, and wiped out half the family fortune.
Or maybe he would turn his education to the business itself. You can imagine him telling dad and the old-timers that there were new and better ways to do things... and that they should be trying to 'maximize shareholder value' by leveraging the firm.
The old timers would shake their heads.
"No... debt doesn't seem like a good idea..." they would say.
Or, "hmmm.... something doesn't seem right..."
But asked to explain why they were reluctant to put the new learning to work, they would have a hard time arguing the point. They would only have hunches and habits, the accumulated wisdom of decades; it wouldn't stand up for long against the mathematical proofs offered by the young MBA!
Finally, the old guard would give up:
"Well, I guess you're right. We can increase our return on equity by borrowing money... I guess that makes sense."
And it did make sense for a while. In 2006, the firm might have been more profitable than ever... and maybe even have bought a corporate jet and begun expanding into new markets.
"Well, I guess Sonny was right," the old man could say to himself. "It is a new era."
And so, the firm like Lehman Bros, which had done business successfully ever since the War Between the States, loads up with debt. And them, when next major cyclical downturn comes, it goes broke!
Julius Caesar never earned an MBA. Nor did Cornelius Vanderbilt. Or Henry Ford. Or Andrew Carnegie. Or practically any of the great successes of business and financial history. MBAs hadn't been invented!
Caesar learned his trade by following in his father's footsteps. His father showed him how to be a praetor, a senator and governor of an Asian province. Caesar learned how to talk to people. He learned how to think. He learned who he could trust. His father made the introductions. His father set the pace. Then Caesar was able to step into his fathers footsteps, and keep on walking.
Caesar did not start from nowhere. He did not start with nothing. He started off where his father left him. He launched his career with the capital his father gave him skills, reputation, experience, money, and contacts.
One of the many under-rated legacies a parent can leave a child is a good reputation. Trust can take generations to build. We trust Mr. Martin to build guitars because his family has been making them for many, many years. We trust Mr. Ford knows how to make cars and Mr. Hershey knows how to make chocolate.
"The thing about doing business in China," said a man sitting next to us on the plane, "is that it can take a very long time to build up trust. And without it, you're lost. They don't trust you. So they won't treat you very well. That's how they protect themselves, by cheating you first."
Trust reduces the cost of doing business. Less need for lawyers and contracts. No need for insurance, bonds and hold-backs. That's one reason ethnic groups tend to prefer to do business internally. They understand one another. They know what to expect. They know who they can trust, and how much.
Even in well-known, open careers such as filmmaking, banking and politics, trust, contacts and 'brand' awareness are extremely important. It's tough to break into acting or politics, for example, but it's a lot easier if your parents had already opened a breach in the wall. The number of people in the trade today whose parents and grandparents were also in it prove the point; there are far more of them than would be predicted by pure chance. Of course, it's easy to see why. The children know how the business works; outsiders don't. They have the contacts; newcomers don't. People in the business trust them to know what to do and how to do it. So, it's much easier to gain entry for someone such as Angelina Jolie (father: Jon Voigt), Michael Douglas (father: Kirk Douglas), Jeff Bridges (father: Lloyd Bridges), or dozens of other well-known political figures.
Of course, that could be said of almost every career and every business whether it is plumbing or haberdashery. One generation lays a foundation. The next can build on it.
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