Advantage--You!
Behavioral New World
February 1, 2023
Comparative advantage—use it to your advantage
Note: This topic might not strike you as being under the umbrella of behavioral economics. However, my broader goal is to improve decision-making, yours and mine, and the idea discussed will help. Further, the perspective offered here will be of greater relevance to younger people, as it focuses on career choices, although possibly of value to older workers who feel that they’ve been beating their heads against the career wall.
Let’s start with an example from personal finance, specifically investing in stocks. A fundamental question quickly arises: As an individual investor, should you spend your time trying to “beat the market” by picking stocks or timing the market? Keep in mind that you are competing with thousands, maybe millions, of investors, with the biggest ones – and even many of the not-so-big ones – likely to be highly trained professionals.
What advantage do you have in this arena? Information? Computing power? Speedy execution of your trades? Almost certainly not.[1] If you’re discouraged by that claim, don’t be—a more optimistic view will emerge as we next examine the nuances of the word “advantage.”
For our purposes, there are two types of advantages. Absolute advantage describes someone who is the very best at something. Consider Usain Bolt in his prime: nobody could run 100 meters faster than he could. Or, arguably, Tom Brady at the top of his (American football) game.
I’m a retired professor and have had a long and generally successful career. But I probably don’t have an absolute advantage at anything (don’t ask about my time in the 100-meter dash).[2] And yet I have had a productive and satisfying work life. How is that possible?
Comparative advantage is an idea from international economics that shows that countries can gain by specialization of production (and then by trading with other countries that have specialized in producing other types of goods). Comparative advantage is dictated by the talents and resources of a country relative to those of other countries.
That description is rather abstract, so let’s bring it down to the individual level. Consider the case of the town’s best (and best compensated) lawyer who also is the best lawn mower in town. Should she mow her lawn? After all, she’s the best mower of lawns, right?
From a financial perspective, the answer is “No” (“Yes,” if she really enjoys mowing her lawn, but that’s not a financial consideration). Why? Because the opportunity cost of her time is high. Taking an hour to mow her lawn means foregoing her hourly billing rate, say, $500. Instead, she could hire someone for $50 to mow, freeing her up to make $500.
This example is admittedly simplified but gets the point across. The lawyer has an absolute advantage in both practicing law and lawn mowing, but her comparative advantage is practicing law. Conversely, the comparative advantage of the person hired to mow her lawn is mowing lawns.
What this means is that you have a comparative advantage (perhaps more than one) in something. The trick is to figure out what that something is. You might start by asking: What talents and interests am I passionate about? There might be clues there. Tim Ferriss, he of podcast fame, suggests asking, “What do you find easy to do that your friends find hard to do?” A book like What Color Is Your Parachute? 2022 could also be of help.[3] The right life coach could help.
For those of you some years into your careers: Beware a variation of the Dunning-Kruger effect, the subject of my July 2021 newsletter. Specifically, it is easy to believe that your competence in one arena maps over neatly to another. I’m thinking of successful lawyers, physicians, and others who decide that they will be good at investing on their own. “Gee, how hard could that be?” Answer: At best, harder than you think.
The broad point here is really just common sense: When making that very large decision about which vocation to pursue, it is optimal to choose one that affords you a competitive advantage (as it is sometimes called in management circles). Your talents and passions will help guide you in this decision, as will your willingness to devote the necessary years of training along your chosen path. Don’t forget the environment in which you will be working or competing.[4] You may have a passion for stock picking, but the highly competitive nature of financial markets suggests that you will have a hard time succeeding against those with a real advantage in this territory.
[1] You don’t have to take my word for it. Mark Cuban, entrepreneur and owner of the Dallas Mavericks, puts it this way: “Unless you think you’ve done more research and have better insight on a stock [or the market, I would add] than a multibillion-dollar hedge fund, why are you trading?” Good question!
[2] If you make the category narrow enough, you can be the absolute best, e.g., best male parent to my children. But beware the “World’s Best Dad” mug—that’s absolute advantage.
[3] I’m not on commission 😊 and there are other books of this genre.
[4] One way to evaluate the environment is the employment outlook of the U.S. Bureau of Labor Statistics by industry/sector https://www.bls.gov/emp/