What Modern Portfolio Theory Can Teach You About Your Job Situation
What if you could look at your current job situation through the same lens as you make investment decisions? When looking at your investment portfolio, you will normally aim at a tolerable risk level and then seek to maximize the returns within this risk. Modern Portfolio Theory (MPT) has two important concepts that can be applied when assessing your current job situation. The first is the concept of the efficient frontier, and the second is the concept of diversification. In this article, we will not be diving into the mathematics of working out an optimal portfolio, as the career landscape is a bit murkier to classify than financial assets. Before we dive into the concepts of MPT, let us first take a quick detour about the trade-offs that most of us experience in our daily jobs.
The Trade-offs in Most Jobs
Let’s face it. When we start in a job we enter a swap agreement, in which we exchange our time for money. When we do this exchange, we pay the opportunity cost of not doing something we would rather do. This could be anything from hitting the gym, spending time with family or loved ones, to spending time on your preferred hobby. So unless you are one of select lucky few people where your daily job coincides with what you absolutely love to do, you are subject to the trade-off where you spend time on something less desirable, rather than spending it on what you really want to do, in order to earn money.
This sounds a bit cynical, and often the job situation is much more nuanced than described above. When it comes to financial benefits, some of us may be lucky enough to earn bonuses or take part in a profit-sharing scheme. We may be up for promotions that lead to more desirable career paths. Hopefully, you also have good colleagues that are fun and inspiring to be around, which makes being at work fun rather than dreadful. On the other side, you will from time to time, have to work more hours than you want to, and do tasks that you really would rather not. A job, much like a financial asset, periodically yields positive and negative returns. And ultimately you are most likely trading your time for money, instead of using it on something you would rather do.
A Brief Primer on Modern Portfolio Theory
Modern Portfolio Theory expresses the optimal relationship between the returns of a portfolio and the risk taken to achieve that return. Plotting all the optimal combinations of expected returns and their associated risk, you get what is called the efficient frontier. This is shown in the figure below.
The way to read this diagram is that you choose either the risk you can tolerate, and then seek to maximize your returns, or pick the expected returns you wish to achieve and then seek to minimize your risk. This is done by combining many different assets into your portfolio, and this process is called diversification.
MPT as a Framework For You Current Job Situation
To start out applying MPT to your current job situation, we need to pick two variables so we can plot them against each other. Obviously, the counterpart to the expected return on assets would be the expected salary of taking the job. Rather than risk, we choose to plot the pain you incur taking on that job. Again it is important to not think of pain as something directly inflicted upon you, but rather in the terms of, that it takes time from something you would rather be doing. Also, a job may be very well paid, but you have to do something you find inherently boring and dissatisfying, and you may have alternative job opportunities that you will enjoy more, but for less monetary value. We also choose to allocate time to jobs, rather than allocating money to various investment vehicles.
Obviously, the pain incurred, or sacrifice is more multidimensional than the standard deviation for financial assets, and also less neutral. Certainly, many of our jobs may not feel like we are sacrificing anything, but simply from a time perspective, there is usually a high correlation between the salary you take home, the hours you have to put in, and the pressure you may feel from work.
Plotting Your Options
It may be easy to think that there really is only one point, and that is your current job, with pay and the pains it comes with. But ask around with your friends and colleagues that have pursued careers elsewhere. Ask them about how they find their jobs and their benefits. This will give you a few more data points. However, there are other options. Chances are that you have a hobby or something that you are good at doing, besides what you do in your job. While it may not generate any revenue right now, with a little effort you may be able to turn that hobby into a revenue stream. If you don’t think you have a hobby that can be turned profitable, you may consider seeing if you can turn the skills that pay your current paycheck into a little side-business. Finally, you may also have alternative income streams, such as subletting a room out, dividends from stocks, and so on. Plotting all this in gives you a pretty good idea of what your current situation is and the immediate options you have around you. Also, notice the different return profiles these options have. In most jobs, you will take home either an hourly or fixed salary, with an upside either being a bonus, or a promotion. A small side business will most likely not generate a lot of income in the beginning. But if you manage to come up with a successful product, things may take off very quickly.
Connecting The Dots
With all the options lined up, you may start seeing some immediate wins. If you stuck around in the same job for a couple of years, chances are you are underpaid compared to your peers that have switched jobs. If this sounds off, or unfair to you, think of it this way instead: Your peers have on a regular basis compared the value of their skills in the labor market, found out they were not currently paid their fair value, and have taken action on it. Unless you happen to work for a very generous corporation, chances are if you haven’t checked what your fair value is, you are most likely getting the short end of the stick. But what about the risk you say, I am comfortable in my current position, and shopping around for other jobs seems terribly risky, what if my boss finds out I don’t like my current job? It may indeed feel that way, but initially, you will spend a couple of hours researching opportunities, sending cover letters, and attending interviews. Finally, if you are offered a better paid, maybe even a more interesting job, what is your downside really? If there is not anything good out there, you still have your current job, and your boss will most likely not find out that you are looking for something else.
So you may be able to land a comparable but better-paid job. That is a quick win. However, in plotting out your various other options you may realize that there may be another mix of revenue streams that better fit the balance of pain/sacrifice and income. Rather than working overtime, for a little extra, you may choose to spend that time on setting up a small side business. You may also choose to sublet a room out to someone, to save a little extra on the side and be less dependent on your primary income source. If you build up several income streams, each with its own return profiles, your income will also be less prone to economic shocks. If you somehow lose your job, even though your total income may decrease, you will still have some left, from your other income streams. Also, you have more chances of an upside. If your small side business starts taking off, you can allocate more time to it. If you use the revenue stream you get from subletting a room to bring down your mortgage, you will have more room in your budget, for investments in your side business, the financial markets, or simply just on things you enjoy. Finally having several income streams gives you the power to cut one of them if you find out it is not worth the hassle, and spend your time elsewhere. This is much harder to do if you only have a single income stream. In other words, you start valuing your time and looking at things as a whole. That is the power of diversification.
Conclusion
Most job situations are complex. Even if you are just working a single job and taking home a fixed monthly salary, while this seems inherently simple, things are actually way more complex, simply because of all the alternatives, you may consider. I hope that after reading this article you have managed to scratch a bit through this surface of perceived simplicity, and started looking at some of the more complex questions that reside underneath it. And these questions are healthy to both ask and try to answer. Is your current job the best way to spend your time? Do you have untapped potential in one of your hobbies, that you could turn into a profit while enjoying doing so? Do you have alternative possible income streams available? The situation and options available are unique for each of us. There is no fixed rule-book. But the first step towards an optimal solution is raising these questions and then starting to think about possible outcomes and adjust your situation accordingly. I hope this article has served as an inspiration to do just that. Best of luck.
