A Tale of Two Brothers

Bugatti Veyron (Photo credit: Wikipedia)

One of my favourite books is “Economics in One Lesson“, by Henry Hazlitt. If you have not yet read this yet, I highly recommend that you go and purchase a copy. The book has also been made available online for free through the Mises Institute and its generous donors.

One of my favourite lessons from the book is the lessons of the two brothers, which comes from Bastiat. I will adapt the story and the sums to today and paraphrase the argument, but the lesson will remain the same.

Imagine that there are two brothers, Jack and John, who have just inherited $10,000,000 each from their recently deceased grandfather. The money is setup in a fund that pays out 4%, or $400,000 each year. One brother, John, is the type that is hated by certain liberal and spend-happy types: He loves to save his money, and invest it for the future. The other, Jack, is loved by that same group: He spends his money for the moment, and lives for the present.

TEN MILLION, AND A CHOICE

Jack likes to live it up and party on the town. He drives an expensive Bugatti Veyron, dines at the most expensive restaurants, and attends exclusive parties with celebrities and hot supermodels. He has dozens of friends all over the world, people greet him everywhere he goes, and everyone loves him. He is living the good live, spending money, creating jobs, but this lifestyle comes at a cost: The $400,000 salary from his portfolio is not enough to cover all of it, and he spends a full $1,000,000 each year. That’s only 10% of the total, and he has a lot of hedge fund friends, so he is not too worried about the money running out, even though he knows that there is a risk. He is living the good life.

John, on the other hand, is far more frugal. He likes to go travelling around the world, but he stays in three and four star hotels when he gets there. He drives a Mercedes, lives in an upper-middle class neighbourhood, and lives a pretty normal life. He only spends about $100,000 of his $400,000 salary. He gives another $40,000 to charitable causes, and re-invests the remaining $260,000. People don’t take much notice of him, and some wonder why he doesn’t spend more money.

Some compare his spending to Jack’s and say “Well, you know, Jack is doing a lot more to support the economy than you are. Look at all of the jobs he is creating.” John, however, has a rebuttal in mind. “Sure, Jack is spending more money, but a lot of his spending is going toward frivolous ends, and his capital is diminishing with each passing day. What I give away to charity ends up getting spent by those who need it, and creates jobs in areas where they need it. What I reinvest is spread across many companies, each of which uses the investment to expand their lines of production and develop new technologies. So in the end, my investment creates just as much if not more, it’s just done in a more indirect manner.”

GOOD TIMES DON’T LAST FOREVER, UNLESS YOU DO SOMETHING ABOUT IT

Six years goes by, and the stock market crashes, wiping out 50% of stock valuations. Jack’s hedge funds suffer an 80% decline, and he ends up spending all of his remaining funds that year. He still has a home and a car, and he has a few other assets he can sell off to cover his daily needs, but his days of high living are over. No more expensive nights out at the finest clubs, no more parties on yachts, and no more high-stakes poker games. People no longer greet him, and his friends have moved on. His hedge fund friends are ashamed to go near him, and his supermodel ex-girlfriend won’t even talk to him.

John, on the other hand, suffers no decline in his standard of living. In the preceding years, his $10 million next egg had grown to $17 million, and the 50% decline left it at $7 million, more than enough for an income of $100,000 a year. Over the next three years, the markets rebound, and he soon is back to $15 million. He feels comfortable increasing his spending to $200,000 a year, and brings his wife on more vacations to Hawaii. As his capital grows, more funds are made available for businesses to invest, and things just keep on getting better.

THE BEST BALANCE LIES IN THE MIDDLE

Don’t listen to those that try to make you feel bad for saving your money, as their argument is complete BS. At the same time, there is no need to be cheap. There is a middle way where you can get the most out of your money for today, and for the future.