How Older Economists Retired Rich
Reality Check (Oct. 9, 2012)
Most of the academic economists I know were able to retire rich. I define "rich" in a special way: the ability to quit your day job, retire permanently, and not suffer a reduction in your lifestyle. There are a lot of people who think the government has promised to enable them to achieve this. There are relatively few people who will be able to do this. There is therefore a political head-on crash facing every Western industrial nation.
The academic economists I have known well were able to begin their careers early, and these careers involved steady salaries. They were very frugal individuals. They saved their money, and it did not matter much the particular markets in which they invested.
Henry Hazlitt was a friend of mine. I was a young man, and he was kind enough to talk to me over the years. Hazlitt had a tremendous advantage over other economists. He never went to college. So, he taught himself economics, and he taught himself by reading voluminously in the works of economists who still wrote in something resembling English. The economists who wrote this way for the most part had a fairly clear understanding of cause and effect in economics. In other words, they were not Keynesians.
So, he was able to get a clear grasp of economic logic, and at the same time, he was a frugal man. He did not get rich because of his understanding of Austrian School economics. He got rich because of his clear understanding that you have to save, and save like a maniac, from an early age, in order to get compound interest on your side.
Hazlitt died at the age of 98. He entered the job market around 1913. That was early in the year that the Federal Reserve was created. He went through the great crises of American economic life: World War I, the recession of 1921, the great boom of the 1920s, the Great Depression, World War II, and the post-World War II expansion. Through all of this, he continued to save. Because he did not have children, he was able to save more than most people do. When he died, he left a sizable estate to the Foundation for Economic Education. He had enjoyed a long career as a writer, and he retired in comfort. I would call him rich. But he was not rich because of any particular skill that he had in beating the capital markets.
Another economist I knew who died rich, according to my definition, was Hans Sennholz. As an immigrant from Germany in the early 1950s, he was extremely frugal. He once told me that in his early years he saved half of his income. He got a job at Grove City College in 1955, and he held that job until 1992. He bought real estate throughout the entire period. Then, after he retired in 1992, he took over running the Foundation for Economic Education for the next five years. So, his expenses then were close to zero -- free rent -- and he was able to save even more money. By the time he really did retire, he had a large portfolio of houses and even a small hotel. That income sustained him, and it still sustains his widow.
When I worked for the Foundation for Economic Education, there was a man on the staff name Charlie Curtis. Except to serve as a kind of part-time accountant, I never figured out what Charlie did for a living. But he was well-paid, and he had been well paid as an academic by the time I met him for at least 30 years. As he freely admitted, he simply bought stocks and held them. That meant that he started buying stocks at the beginning of World War II, and he kept buying them. By the time he retired, he was worth a lot of money. He was there during the great expansion: the boom for stocks. That was back when stocks paid 4% dividends. He reinvested the dividends. So, I'm sure he had a comfortable retirement.
Again and again, I heard this story. The economists I knew who did well had steady incomes, and they were thrifty. I never met any of them who claimed to have a technique for predicting the markets. In fact, because most of them were Austrian School economists, they denied the possibility of having such formulas. They just saved a lot of their money, and in Sennholz's case, he took on a lot of debt to buy houses, and his renters paid off this debt.
Most economists have TIAA/CREF retirement programs, which they do not personally manage. They have high salaries, or least those of my generation did, because they got hired early. They kept their jobs, they saved their money. Then they bought their own homes. Their assets when they retired constituted their homes, which they had probably paid off, and their retirement portfolio. I don't know if all of them will make it to age 85 in comfortable surroundings, but at least they have a shot at it. They were employed by an academic cartel, and they enjoyed above-average salaries because they had gotten through the barriers of entry into this cartel. They got in early enough so that their salaries were above market. Younger economists starting out today do not have this advantage. They are not going to retire rich.
The point I'm making is this: economists do not retire rich because of their skills at predicting markets. They retire rich, assuming the next generation will do so, only because they got into an academic cartel, got a relatively high-paying job early in their careers, and they saved maniacally during their entire careers.
HOOPS, NOT FORMULAS
This leads me to a conclusion. The success of economists in accumulating capital is based on their having gone through a series of academic hoops that have nothing to do with the understanding of actual markets. They lacked entrepreneurship in the general sense of being able to forecast markets, and invest in terms of their forecasts. They used conventional means of achieving wealth, and the only major exception I ever knew in this regard was Sennholz, who did a fairly conventional thing when he invested in real estate. He understood enough about local market conditions so that he could identify a house that was a bargain.
He once told me that one of his secrets was to buy houses that had been infested with termites. He said that most sellers are terrified of termites, and they were willing to sell the house at substantially below market price. He said he was always able to repair the problems created by the termites, and he did so in a fraction of what the discount was that the seller was willing to sustain in order to get rid of the house. I suppose you could call that a form of economic forecasting, but it is not the kind of forecasting the economists generally employ in making investments.
This is why I recommend to people who are deep into a study of economic theory, and who have not yet made any long-term plans, are making a mistake. They should stop studying economic theory, and they start making long-term plans. Even bad long-term plans are better than no long-term plans, because it is possible to revise a bad plan. The discipline of making the plan in the first place is the key factor that makes the beneficial outcome of the plan more likely. It is not the details of the plan that are the secrets of financial success.
The person who believes that by studying one more book about monetary theory, or one more book about entrepreneurial theory, is going to enable him to beat the markets, is making a serious mistake.
One of the major theorists of entrepreneurship in our day is retired professor Israel Kirzner, who was a student of Ludwig von Mises. Kirzner's theory of entrepreneurship is straightforward. The entrepreneur possesses the ability to make accurate judgments about future supply and demand. This ability cannot be taught, Kirzner argues. If it could be taught, entrepreneurial returns would decline through competition to be nothing more than conventional returns for a particular asset class and its risk. Risk is not the same as entrepreneurship, he argues, as did Mises, and also as did University of Chicago economist Frank Knight. Risk can be analyzed mathematically. Risk analysis is at the heart of all insurance contracts. This is not the same as uncertainty, which is not subject to mathematical analysis.
If Kirzner is right, and I think he is right, then the ability to make forecasts does not rely on the theoretical knowledge of how entrepreneurship shapes an economy. The ability to describe in theory how entrepreneurship shapes an economy is not the same as the ability to make accurate judgments about the future state of markets.
A wise economist tells his students early in the semester that what they are going to learn in his classroom will not make them better investors. In my opinion, the experience of going through a standard economic textbook, especially a Keynesian economic textbook, will probably serve as a hindrance against the ability of making accurate economic forecast. Keynes himself was a successful investor, and maybe he did not use inside information from his cronies in the Treasury Department to amass his wealth, but he never had a degree in economics. He was a mathematician. He wrote a book on probability theory in 1921. This did not keep him from losing most of his wealth in the Great Depression, which he did not foresee. Neither did his rival, Irving Fisher.
I have been able to predict every major recession over the last 25 years because I recognized early that an inverted yield curve always leads to a recession. An inverted yield curve is one in which short-term, 90-day Treasury-bill rates have a higher rate of interest than long-term thirty-year T-bond rates. These days, however, it is much more difficult to use this tool, because with short-term Treasury bill interest rates at essentially zero, and because interest rates cannot go negative for more than a few hours, you cannot get an inverted yield curve anymore.
ANALYSIS PARALYSIS
I feel sorry for people who do not make long-term plans because they think they do not have enough knowledge of economic theory or statistical facts. They are victims of what is sometimes called analysis paralysis. They bury themselves in either theory or statistics in a vain attempt to find some safe approach to making above-average returns. There is no safe approach to make above-average returns. That is why the returns are above-average. They are offset by people who make below average returns.
When people bury themselves in academic materials, or when they pursue highly complex, arcane theories of investing, they lose the only irreplaceable resource they possess: time. When you lose time in the realm of investing, you lose the effect of compound economic growth. The earlier you get on the side of compound economic growth, the more likely you will be able to retire rich.
Because most people do not do this early enough, or because they find that what they believed would be a compound economic growth investment class turned out to be anything but, they find themselves at age 50 looking down the road at what is obviously not going to be a comfortable retirement. They did not have above-average salaries as a result of their membership in an academic cartel. They never got into that cartel. They were paid market salaries, and they were not maniacal about thrift. They bumped along for two or three decades, living the lifestyle of the consumption-driven Americans around them. Then they find that they are in the same situation as their peers.
RESERVATION DEMAND
The difference is this: they recognize their situation, and their peers refuse to face the facts. They understand that they will not be able to leave the workforce and still enjoy retirement that does not mandate a dramatic reduction in their lifestyle. Their peers do not see this yet.
People who want to retire at age 65 and live comfortable lives forget the basis of free market economics, namely, that everyone who does not use an asset according to the highest demands of customers must suffer a loss. If a person goes into retirement when customers are still out there, bidding for his services, he will suffer a loss. Whatever the customers would have paid him for his time is permanently lost.
Retirement time is the classic example of what is sometimes called "reservation demand." Reservation demand is when the potential seller of an asset decides to keep it for himself. He becomes the highest bidder in the market for the particular resource. His high bid wins. But monies bidding for his own time, it is costing him whatever income he might have earned. He is in a position to trade leisure time for income, and he decides to use that time for leisure. His lifestyle involves leisure, but he must pay for this leisure.
The problem today is that people are living longer than they expected. They are outliving their capital resources. They will run out of income before they run out of leisure. At that point, they will face the grim reality that they have lost the skills which they possessed at the time of their retirement. The number of customers who are bidding actively for their services has declined. They could have taken advantage of this demand at the time of their retirement, but they decided that leisure was a better form of income than money. By the time they figure out that they have paid for this leisure through capital depletion, they are not in a position to generate a monetary income that they could have generated, had they not left the labor force a decade or more earlier.
CONCLUSION
I recommend to my readers that they sit down and carefully assess what it will cost them in the future to sustain their lifestyles. They should also factor in the Great Default, namely, when the federal government hikes the age of eligibility for Social Security income, and when it imposes price controls and rationing of medical services. Under these conditions, people are going to have to go to the black market, or physicians outside the United States, to get the treatment they need, and by that time, the United States dollar would probably no longer be the world's reserve currency. It depends on somebody's age.
When I say that it is better to have a bad plan than no plan, I really mean it. It is better to go to the discipline of thinking through your future than it is to assume that everything will work out by itself in a way that will enable you to enjoy the same lifestyle that you had before you retired.