How to Become Smarter (54 page)

People who spend their disposable income on gambling instead of saving will reduce their chances of achieving financial independence at the retirement age. This is because they will forgo an opportunity to invest profitably thanks to such wasteful activities as the lottery. Put another way, these people will give up low-risk financial independence at the retirement age in exchange for a dream about quick and easy financial independence tomorrow. Because of the
compounding
of investment returns, the failure to save and invest today will result in a bigger loss in the future than it may seem at first glance. Let’s say an index fund provides you with 7.5% annual returns on average over a period of 30 years. If you lose $1000 through gambling this year, this means that you gave up the opportunity to have 8,754 dollars in 30 years. (This is $1000 times 1.075
³⁰
. The amount may be somewhat smaller because you may have to pay taxes when you cash out. It depends on your retirement plan.)

O
NLINE
P
OKER
.
My view is that internet poker is a form of pure gambling, where winning is random and unrelated to skill. We saw earlier that games where the outcome is purely random will cause losses for the majority of people and significant gains for providers of the gambling activities.
Live
poker is different in that the skills do matter and a minority of talented people can win consistently over time, even though the outcome of any one game is random. Internet poker is pure gambling because it obviates the two advantages that a skilled player can have:

1. correct estimation of odds of winning or losing a hand;
   
2. “acting” (such as bluffing) and “reading” of other players.
   

The use of odds calculators on poker websites is widespread and not against the rules. Odds calculators eliminate the difference between skilled and unskilled players because this software will allow anyone to make intelligent decisions in a poker game. An odds calculator plugs into an online poker table and shows you pot odds and simple odds of winning a hand, no input of data is necessary. This software often has other useful features, such as tracking and analysis of behavior of the people you are playing against. For example, after you have played 10 or 20 hands, it can tell you if a player is tight, loose, aggressive, or passive. The software can also show you discarded cards in some cases and you can find out if a player was bluffing
after the fact
.

Bluffing, reading of players, and other psychological tricks that are crucial in live poker are irrelevant in online poker. You can neither see nor hear your opponents. In case you are wondering, there is no software that will allow you to determine if somebody is bluffing or not. Some people might say that you can vary the decision time or read what others are typing in the chat box or use the player profiles compiled by your poker software. These methods are useless and do not make online poker a “people game” that live poker is. Online poker is a mechanical game similar to a slot machine.

Most poker professionals do not list online poker tournaments among their achievements. This is because you cannot win consistently in online poker and the outcome of this game is random regardless of your level of skills. In live poker championships, you see the same group of people among the winners year after year. This suggests that skills and talents matter in live poker (but there is a great deal of luck too). In online poker championships, the winners are random and you never see the same people win this game repeatedly. These observations suggest that luck is all that matters in internet poker. In conclusion, my advice is: don’t waste your time and money on internet poker. Also, you need to keep in mind that live poker is not for everyone and may be illegal in your geographical area. You need to check your local laws and regulations. The influence of luck in live poker is substantial and only a small minority of participants can make money consistently in this occupation. Therefore, live poker is not for everyone.

On the pages above, we reviewed the most popular types of activities that are believed to lead to “financial freedom.” We discussed
a)
investing in a “lucky stock;”
b)
investing in your own startup business;
c)
trading of financial instruments;
d)
profit systems in a box;
e)
the lottery and other pure gambling activities; and
f)
online poker. The analysis shows that these activities are unlikely to help you achieve self-employment (even less likely wealth) and instead, will lead to financial losses with high probability. Let’s say you hate your boss, are sick of your job, and want to become self-employed. Should you start trading forex, play online poker, sign up with a multilevel marketing system, or engage in any other disadvantageous activities we discussed above? No, you shouldn’t. Either think of something else or, as the saying goes, be wise enough to accept things that you cannot change.

As we saw above, there are no investment opportunities out there that guarantee huge returns with low risk. In rare situations when such opportunities do arise, the discoverer exploits them to the fullest and does not advertise them in books or on TV. If someone’s purpose of investing is to get rich, this means that this person is relying on luck. For example, he wants to invest in a single stock, a single startup company, or a bunch of lottery tickets. This person will most likely sustain losses. On the other hand, there are at least three types of smart investments that do not require luck. They are: a) a down payment on a mortgage, or if you already have a mortgage, paying off the mortgage faster than necessary; b) government bonds; and c) a stock index fund. These approaches can increase your net worth over decades with low risk. We already discussed government bonds and index funds above and will now talk about investing in your own housing.

Although a mortgage loan can be considered a liability (you owe a lot of money to the bank), an asset (your house or apartment) offsets this liability. This arrangement gradually increases your net worth because it allows you to build your
home equity
, which is the market price of your housing minus what you owe to the bank. Things are more complicated than this because of yearly fluctuations of real estate prices. You will sustain losses if you buy a house and then have to sell it several years later, during a downturn in the prices of real estate. Nonetheless, over decades, the prices of residential real estate go up at an average annual rate of 5.9% in the U.S. [
529
]. Therefore, if you are not moving frequently, getting a mortgage is a good idea. A person or a family who rent housing are losing their money in the amount of rent each month and are building their landlady’s home equity. In other words, if you have a mortgage, you are investing your monthly mortgage payments into your own housing. Given the price appreciation data of real estate cited above, we can conclude that the long-term return on investment in mortgage payments is close to zero. This means that mortgage payments build your net worth in the same way as if you were depositing them into a savings account that pays 0% interest. This is due to interest you are paying to the bank on your mortgage as well as housing insurance and property taxes. They will offset the long-term increase of real estate prices. Nevertheless, you are in a better situation than a person or family who rent their housing. They are throwing away their monthly rent payments instead of depositing them into the zero-interest savings account, that is, the mortgage loan. Therefore, getting a fixed-rate mortgage is not a bad decision if the mortgage payments are comparable to the rent you are paying. Mortgage rates are comparable to inflation rates in many countries. If your salary increases at the same rate as inflation or faster due to promotions, raises, or indexing, then you may consider your mortgage an interest-free loan. Thus, investing in the housing that you can afford is a good investment strategy. The key phrase here is “housing that you can afford,” meaning that you should be able to easily make the monthly mortgage payments at your level of income. If the sum of your monthly debt payments, including mortgage, constitutes about 25% of your gross monthly income (before taxes and contributions), this is an
affordable
mortgage loan. In conclusion, if you have savings to invest, you may consider these three smart investments: your own housing, government bonds, and an index fund. With stock indexes, keep in mind the above example of the Nikkei 225 and consider investing in a global stock index. Since I am not a certified financial adviser, you will have to obtain further information on investing elsewhere.

Returning to the subject of wealth, some people do get rich quickly, so why can’t you? Do these people work harder or are they smarter than you are? The weight of evidence suggests that this is not the case. For example, higher than average intelligence correlates well with higher than average income, but huge intelligence does not correlate with huge income; there is no correlation between IQ and net worth [
24
].

T
HE
R
OLE OF
H
ARD
W
ORK
.
There are plenty of people in the world who work excessive hours and who will not get rich (for example, many of the owners of startup companies). On the other hand, it is possible to become wealthy without working (for instance, through the lottery, inheritance, or marriage) or without trying hard (for example, if your parents are well-connected). A person who has a close relative who is a Hollywood star or director has a better chance of achieving big success than the rest of the population. Therefore, hard work is neither a necessary nor a sufficient condition for getting rich. We can define wealth as being in the top 1% of net worth in the population. The above observations suggest that achievement of wealth does not require either hard work or high intelligence, in general. Nevertheless, it is possible that attainment of wealth requires high intelligence and hard work if the person is trying to do so
independently
. The relevant research data are lacking. Although hard work is subject to choice, intelligence is not (people are not born with equal mental abilities or identical brains [
987
]). Therefore, the influence of luck on your financial future is substantial even if we consider only these two factors.

A convenient indicator of hard work (i.e. effort) is average hours worked per week (or per year). There are some limited scientific data on the relationship between wealth and work hours. Dr. Eric French investigated the effects of net worth, wages, and health on work hours and on the likelihood of retirement. According to Figure 2 of the article [
994
], wealth increases with age (a well-known fact), but the number of hours worked per year decreases with age, on average. Thus, if we use average numbers for all age groups in the United States, higher net worth correlates with fewer work hours. I was unable to find studies on the relationship of work hours and wealth within a single age group.

If we look at income, research shows that the correlation of hard work and income is weak and limited. Among different countries, if we compare GDP per capita and average annual hours worked (2010 data), it is difficult to see a correlation. For example, Norway and Luxemburg have higher GDP per capita than the U.S., but they work fewer hours on average. On the other hand, South Korea and Mexico work longer hours than the U.S., but they have smaller incomes per capita, on average. If we look at a single country, in the United States, there is a moderate trend for longer work hours among higher income groups [
995
]. But the small differences in work hours cannot explain big differences in incomes. For example, people earning more than $500,000 a year work only 17% more hours than people making between $50,000 and $60,000. Also keep in mind that these are average numbers and there are people making $50,000 a year who work longer hours than some of those earning $500,000 [
996
]. In the graph “income vs. hours” there is a plateau around 50 hours per week (meaning that higher incomes no longer correlate with more hours worked). For example, the difference in the hours worked between people earning $250,000-500,000 per year and those earning more than $500,000 is negligible: both groups at around 49 hours a week. In New Zealand, the percentage of workers who earn more than 100,000 NZ dollars peaks around 50 hours per week and declines among people working more than 60 hours per week [
996
]. These data suggest that people earning the highest incomes in New Zealand are unlikely to work more than 50 hours per week.

Note that we cannot assume that the longer hours
cause
higher incomes, based on the above data. The reverse is also possible: higher incomes cause slightly longer work hours. For instance, a high earner can hire a maid and spend less time on household chores, choosing to devote more time to the career. We can conclude that the correlation between hard work and income is weak. Some factors other than hard work must have more influence on income.

T
HE
R
OLE OF
L
UCK
.
There are many factors that influence the chances of getting rich. Most of these factors are not subject to free choice and have to do with luck. A combination of the following random factors predetermines the financial future of a person, with high probability: