The Difference Between Self-Employment and "Normal" Jobs
It's all about the distribution of outcomes.
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Now to today’s piece 🤝
Imagine a 10-story Manhattan residential apartment building, in which each floor is nicer and more opulent than the last.
The ground floor is home to the cheapest apartments: studios with iron bars over the windows, leaky faucets, and the occasional rat or three. Sure, it’s habitable, and the hot water (occasionally) works, but it’s far from desirable.
As you move up to the second and third floors, the rodents disappear, the iron bars are removed, the plumbing is secure, and your bedroom, which is separate from your living room and kitchen, now has enough room for a queen mattress and a full-sized desk. It might not be your dream home, but it gets the job done.
On floors 4-6, your checkerboard floor tiles are switched out for hardwood, an in-unit washer and dryer replaces your weekly commute to wash your clothes, and your kitchen and living room are finally separate entities. (In most of America, these things are “normal.” In New York, an in-unit washer and dryer is a status symbol.)
Floors 7-9 bring beautiful views of the city, access to a balcony or deck, a dining room that fits a table for eight, a small home office, a living room that can hold dozens of friends, and one of those showers where the water pours directly from holes in the ceiling, like a waterfall for folks who don’t live anywhere near nature.
And then we have floor 10, the penthouse. Your floor has its own elevator that other residents can’t access. Your living room, grand piano included, has an unobstructed view of the East River, and it’s plenty big enough to host a cocktail party for 100 of your closest friends. Your floors are made of marble, your bookshelves are full of novels that you’ll never read (but still look impressive), you have one of those televisions that retracts into the floor on command, and you don’t have to lift a finger in the kitchen, because your chef handles the cooking for you.
Can you tell I’ve been apartment hunting this week?
So where will you reside? Well, that’s up to fate. Now imagine that you have two choices:
Choice A: you have a 10% chance of living on floors 2 and 3, an 80% chance of floors 4-6, and a 10% chance of floors 7-9. You are guaranteed to avoid the dredges of the ground floor, but you’ll never reach the penthouse either.
Choice B: You have a 20% chance of living on the ground floor, a 20% chance of landing in the penthouse, a 55% chance of landing anywhere between floors 2 and 9, and a 5% chance of sleeping outside the building altogether. Maybe you become Jay Gatsby, maybe you ask Mr. Gatsby for money on the corner, or maybe you end up somewhere in the middle.
Which choice do you make?
In 2023 in the United States of America, you have two options for employment:
1) Working for someone else
2) Working for yourself
Critics of traditional employment exclaim, “You’ll never get rich unless you own equity in your work; you have to be your own boss. A salary is no way to reach the top 1% of wealth in the US.”
Critics of self-employment cry, “It’s far too risky to strike out on your own. Sure, there are some success stories, but you will probably crash and fail.”
Both parties believe they are right, and both parties leverage countless data points to support their positions. But both parties are missing the point.
The key isn’t that one form of employment is objectively better than the other. The key is that the distribution of outcomes that accompany different employment types varies.
In the example above, the probabilities of living in different apartments weren’t simply an arbitrary test of your risk tolerance. They serve to highlight the range of outcomes you can expect from different career paths.
Allow me to explain with yet another analogy.
In finance, we use derivatives called options to place leveraged bets and/or hedge our portfolios against downside moves.
The two simplest options are “calls” and “puts.”
You can buy a call option to bet on a stock going up by a certain date. If the stock price increases enough before the option’s expiration date, you will make a lot of money. If the stock doesn’t increase enough by the expiration date, the option expires worthless. You can also get paid upfront to sell call options on stocks that you already own, but you will be obligated to sell those shares at the option’s strike price if the stock price increases past that point, capping your potential gains.
Buying a put option gives you the right to sell that stock at a certain price, no matter how far its price has fallen, allowing you to hedge against declines. Meanwhile, selling a put option obliges you to buy that stock if it falls below your option’s strike price, opening you up to risk if a stock performs poorly.
There is one particular options strategy known as a “collar,” where you sell call options on stocks that you own and use those proceeds to purchase matching put options. This strategy got its name because it “collars” your portfolio: you are protected from downside moves, but your upside is limited thanks to the calls you sold to pay for the insurance.
Mark Cuban famously used a collar to preserve his wealth after selling Broadcast.com to Yahoo for billions right before the Dot Com bubble crashed.
A traditional, salaried job is a collar: the cost of protecting against downside risk is limited upside.
Think of your entry-level salary at your first job in corporate America as the second floor of the building, and your total comp as a high-level VP or director as an apartment on the eighth floor.
Your worst possible outcome, a career that fails to advance, still pays well enough to cover the basics. Meanwhile, a home run career pays handsomely, but it won’t propel you to the upper echelons of wealth. Like Mark Cuban’s Yahoo shares, your career is collared. The potential upside and downside outcomes are range defined.
Working for yourself, on the other hand, is like purchasing call options. If you succeed, the upside will outperform the “normal” career by a magnitude, but if you’re wrong, no one is there to save you. The cost of admission for unlimited upside is the potential for absolute failure. Maybe you become a millionaire, maybe you go bust. Who knows.
Of course, neither path is an all-or-nothing pursuit. There’s nothing wrong with allocating a small portion of a well-diversified portfolio to some more speculative call options, and you certainly don’t have to quit a well-paying job to go all-in on last weekend’s late-night Eureka! moment. In fact, the prudent move for someone looking to start their own thing is to launch it while they’re still working, that way they don’t need the money immediately.
If a stock does well enough, it can still generate insane returns for you despite initially being a small part of your portfolio. If your side hustle takes off, it can still generate life-changing money for you as well, without you having to give up your day job along the way.
That being said, I love a good casino trip, so we’ll stick with the call options. It is just betting on yourself, after all.
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If you work in tech, your finances are probably confusing. When should you exercise? You’ve got money, but where should you put it? What about tax strategies? Compound is personalized wealth management for people in tech — it’s how people at Stripe, Discord, OpenAI, and more make smarter decisions about their money. Check it out here.*
For my fellow writers (and aspiring writers) out there, Tim Denning wrote a great piece on the value of a $5 newsletter.
Matt Levine covered the SEC’s recent crypto crackdown in Matt Levine fashion.
Nick Maggiulli’s latest piece on chasing money after you’re rich is excellent.
I’ve been digging through several of Rob Henderson’s older posts lately, and his piece on the risks of copying high-status people is a must-read.
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