One of the more curious tricks played by late capitalism on the minds of its subjects is conceptually transforming all aspects of life into different forms of capital. From this trick arises the idea of “social” capital, which turns relationships with friends, neighbors, and loved ones into assets that can be assigned a precise value based on discounted future cash flows. Knowledge, education, and experience become “human” capital. Customs and manners become “cultural” capital.
With so many forms of capital available, actual capital — ownership of the country’s productive capacity — puts on a blue suit and tries to blend in with the drapes.
Don’t confuse business, work, and investing
Perhaps because I have my hands in so many pots, I have a particularly acute sense of the difference between business, work, and investing:
- I run a business producing travel hacking and personal finance content on the internet;
- I have a bunch of jobs, where I do work and receive pay;
- and I own a bunch of Vanguard mutual funds, one Vanguard ETF, and 50 shares each of Fannie Mae and Freddie Mac (because gambling is fun and this Mnuchin guy is going to make me rich).
A business makes money from customers
In my business, I sell ad space (through Google Adsense), subscriptions, and Patreon patronages or whatever they’re called. In order to entice customers, I have to be funny, smart, sarcastic, valuable, or whatever else customers want in order to voluntarily pay me.
This is the nature of business: you can put as much time or money into an idea as you like, but if no one wants to buy anything from you, you won’t make any money.
A job makes money from an employer
The defining characteristic of a job, as opposed to a business, is that you are paid for your work. Now, over the history of capitalism different models have been used to pay workers so I don’t want to get hung up on a single model: there are hourly, salaried, piece-work, and commission models of employment, and plenty of others I’ve probably never heard of. What they have in common, though, is that the employee is entitled to payment from their employer for the work done regardless of their value to the employer.
The distinction between a business and a job could not be more clear: businesses are paid voluntarily by customers, while workers are required to be paid by their employer. In US law this is even enshrined in the Bankruptcy Code, which places wages owed above the claims of other unsecured creditors.
Investing is an inherently passive enterprise
By “passive” I’m not referring to passively-managed mutual funds, but rather to the nature of investing. Investing is the process of holding an ownership stake in an undertaking you are not running and are not employed in. Unlike a business, where your income depends on how skillfully you execute the undertaking, or a job, where your income depends on your ability to satisfy your employer, when you invest, your income depends entirely on other people’s successful execution of the underlying business. When you buy a bond the return of your coupons and principal depends on someone else earning enough money to make those payments. When you buy a stock your dividends depend on someone else generating enough free cash flow to make those distributions.
Understand which part of your income comes from which activity
The US tax code at times seems deliberately designed to confuse this fundamental distinction between business, work, and investing. For example, many doctors legally organize their practices into “businesses” when what they’re really doing is work: billing insurance companies for services rendered at a predetermined rate. Likewise many actual business owners legally organize a certain portion of their business income as wages, dividends, and capital distributions. And of course hedge funds are rightly famous for deliberately confusing their business activities (attracting capital from investors), work activities (picking investments), and investing activities (sitting around waiting for stock prices to rise or fall) in order to secure the most generous tax treatment for each.
These games can be fun and lucrative (albeit time-consuming) but I would encourage you to be honest about which part of your income actually comes from each enterprise, not for the sake of manipulating your income taxes, but to understand what you’re really being paid for. Owning rental real estate, for instance, is part business (attracting tenants to your buildings), part work (maintenance you do yourself), and part investing (depositing rent checks). Running a blog is all business (attracting readers), while writing for someone else’s blog is all work (whether you’re paid per word, per post, or per month).
Conclusion: find the combination of income sources that works best for you
About 33% of my income is business income, about 66% is income from work, and about 1% is investment income. This is not, notably, how I report it on my tax return. Rather, it reflects the reality of how I’m compensated for different activities: for which do I rely on attracting customers to voluntarily pay me and for which am I paid for the work I do?
I don’t personally privilege any one income source over any other, as each has its own charms:
- running a business has the advantage of making me fully responsible for all my successes and failures, with no one to answer to but myself (unfortunately I’m a terrible boss);
- working jobs has the advantage of being able to focus on a particular task instead of fretting about my impact on the business’s bottom line;
- and investing has the advantage of not requiring (or allowing) any input from me, besides voting the occasional proxy (I always vote against all the director nominees, on principle, and you should too).
I think the rejection of wage work by FIRE types is often a bit overwrought. If you don’t like your job, you ought to get another job. If you don’t like your hours, you ought to work different hours. If you don’t like your co-workers, you ought to find some different co-workers. On the other hand, the idea of working even more hours, with co-workers you like even less, at jobs you hate even more, just to eventually replace your work income with investment income seems at its core like a tragic miscalculation.
My suggestion is to find the combination of income sources across businesses, jobs, and investments, that let you achieve your goals with the minimal amount of existential despair today, not two, five, or ten years in the future.