Why You Must Convert Your Labor Into Capital
There are two ways to create economic value for yourself and your family - labor and capital. On the surface this is fairly self-explanatory, but it has tremendous implications for building wealth, life fulfillment, and achieving financial security.
Labor is obvious and it is everywhere. Most of us start our careers in the labor class, and many stay in the labor class forever. Labor is trading time, energy, and skills for money. This is the janitor, the garbage collector, and the teenager flipping burgers at McDonald’s. It is also surgeons, lawyers, engineers, and the vast majority of high-income professionals and white-collar workers. It is also LeBron James and Shohei Ohtani. There are wildly different rates at which we convert our labor into money, but at a fundamental level, these are all examples of labor.
Capital, on the other hand, is ownership. In this era, it is ownership of productive assets. At the lowest level, this can be money in a savings account paying a nominal interest rate. But the type of capital that we should all strive for is ownership in a company. The book Sapiens: A Brief History of Humankind provides a great summary of the idea of companies as a concept of shared beliefs that enable large-scale human cooperation. It is an intangible entity that can own assets, incur debt, and sue or be sued just like real people can, but importantly it allows for a large number of humans scattered geographically to pursue the creation of economic value together.
For-profit companies have owners. The mom and pop coffee shop might just be owned by a single couple or a family. The large publicly-traded company has millions of owners, in the form of shareholders. A private start-up is owned by its founders and the private investors. The ownership of any company can be delineated in what’s called a capitalization or cap table, which is basically a list of owners and the percentage of the company that each owner owns.
The profits (and potential losses) of the company belongs to its owners. The owners, through the managers of the company as its proxies, decide how to allocate these profits. They can be paid back to the owners through dividends or share buybacks, or reinvested in the company for maintenance or expansion, or used to pay off debt, or to acquire another company. The money ultimately has to go somewhere. Whether it is actually realized to the owners in the form of a cash dividend, it nevertheless belongs to the owner.
Why capital is superior to labor
As a surgeon, I can covert my labor into money at relatively high rates, but it is still labor. If I woke up one day and decided not to go to work, I won’t earn any money. If I wanted to double my income, I typically have to do double the work. Because the money is indexed to my time and energy, very quickly we run into a ceiling of how much we can earn through labor. Basically, the problem is that it is not easily scalable. And as a laborer, I will have to stop working some day because I can no longer physically or mentally do the work.
Capital, on the other hand, is vastly superior to labor. First, it is not indexed linearly to your time and energy. To find an investment that returns 10% per year rather than 5% per year requires knowledge, skill, and temperament. It does not have to take twice the amount of time directly. Similarly, investing $1,000,000 does not typically take 10 times the amount of time it takes to invest $100,000. Once you’ve made the decision, buying 100 shares of a company does not take any longer than buying 10 shares.
Further, it is not constrained to your physical environment. I can research an investment idea from anywhere in the world with an internet connection. I can read about a company at any time of day. I can listen to a podcast while I’m doing chores or exercising. If there’s a blizzard, I don’t have to worry about commuting into the hospital, as I can be just as effective allocating capital in the comfort of my home.
As the owner of a productive asset, it is accruing value for you regardless of what you’re doing. This is why people call this type of passive income “making money while you sleep”. If you own shares of Apple, every time someone in China buys an iPhone, you are getting a little bit of economic value. If you own shares in an ambulatory surgery center (ASC), even if you’re not working there that day, if another surgeon is doing procedures there, you are making money.
Why you must convert labor into capital as fast as you can
There will be a day for all of us in the labor class when we will stop trading our time and energy for money. For a lot of people, this is unfortunately not something they’re doing electively. Maybe they have developed physical ailments that prevent them from doing manual labor. Maybe it’s cognitive impairment. Maybe they’re laid off from their job.
My goal is to have the ability to decide if and when to stop working as a surgeon on my terms. This is a goal that we should all strive for. This is the essence of financial independence. But when we stop trading our labor for money, our labor income will stop. How do we then support our expenses?
This is where capital comes in. During the time that you’re working in the labor class, which is usually where we all start out, it is imperative to save some money and convert it into capital. That capital can then earn money for you independent of what you do. And as you gradually accumulate more and more capital, eventually you’ll reach a tipping point where your capital can generate enough money to support your lifestyle, forever. This is financial independence, and it means you longer need to work as labor. You may still continue to do so, but it will be on your terms, because you want to do it.
And why do I say you should convert labor to capital as fast as you can? It’s because capital has an amazing property called compounding. Compounding is an incredible force. As capital grows, the additional growth becomes a part of the principle, which then creates a larger base for even more growth. It’s how a tiny snowball can become a huge snowball, first gradually, then all of a sudden. But one of the key ingredients to compounding is time. Capital that’s saved in your 20s will grow much more significantly than the same capital that’s saved in your 40s. Of course you need to have a balanced approach towards saving for the future and living now, but time really is of the essence. As Morgan Housel highlighted in The Psychology of Money, one of my favorite books, the reason why Warren Buffett is so wealthy is because he’s been compounding his money for more than 80 years.
In future posts, we’ll further explore what types of capital you should invest in, and how you should allocate it across various types of assets. I find that many of my colleagues and friends in medicine still don’t quite grasp this concept of labor vs. capital. It is a fundamental mental model that’s necessary for financial independence and building wealth.
