If you cut fair deals, you will get paid in the long run
Ethics isn’t something you study; it’s something you do
Nivi: In the “How to Get Rich” tweetstorm you listed things you suggest people study, like programming, sales, reading, writing and arithmetic. One of the items that ended up on the cutting-room floor was ethics, which you also suggest people study.
Naval: I was going to put that out as a concession to people who believe making money is evil and that the only way to make it is to be evil. But then I realized ethics is not necessarily something you study. It’s something you think about—and something you do.
Ethics isn’t something you study; it’s something you do
Everyone has a personal moral code. Where we get our moral code differs for everybody. It’s not like I can point you to a textbook. I can point you to some Roman or Greek text, but that’s not suddenly going to make you ethical.
There’s the Golden Rule: “Do unto others as you would have them do unto you.” Or there’s Nassim Taleb’s Silver Rule, which is, “Don’t do unto others what you don’t want them doing unto you.”
Trust leads to compounding relationships
Once you’ve been in business long enough, you will realize how much of it is about trust. It’s about trust because you want to compound interest. You want to work with trustworthy people for long periods of time without having to reevaluate every discussion or constantly look over your shoulder.
Over time you will gravitate to working with certain kinds of people. Similarly, those people will gravitate to working with other ethical people.
Being ethical attracts other long-term players
Acting ethically turns out to be a selfish imperative. You want to be ethical because it attracts other long-term players in the network. They want to do business with ethical people.
If you build a reputation for being ethical, people eventually will pay you just to do deals through you. Your involvement will validate deals and ensure they get done; because you wouldn’t be involved with low-quality stuff.
In the long run, being ethical pays off—but it’s the very long run. In the short run, being unethical pays off, which is why so many people go for it. It’s short-term greedy.
Being ethical is long-term greedy
You can be ethical simply because you’re long-term greedy. I can even outline a framework for different parts of ethics just based on the idea of long-term selfishness.
For example, you want to be honest because it leaves you with a clear mind. You don’t want two threads running in your head, one with the lies you tell —and now have to keep track of—and the other with the truth. If you are honest, you only have to think about one thing at a time, which frees up mental energy and makes you a clearer thinker.
Also, by being honest you’re rejecting people who only want to hear pretty lies. You force those people out of your network. Sometimes it’s painful, especially with friends and family; but over the long term you create room for the people who like you exactly the way that you are. That is a selfish reason to be honest.
If you cut fair deals, you will get paid in the long run
Negotiations offer another good example. If you’re the kind of person who always tries to get the best deal for yourself, you will win a lot of early deals and it will feel very good.
On the other hand, a few people will recognize that you’re always scrabbling and not acting fairly, and they will tend to avoid you. Over time those are the people who end up being the dealmakers in the network. People go to them for a fair shake or to figure out what’s fair.
If you cut people fair deals, you won’t get paid in the short term. But over the long term, everybody will want to deal with you. You end up being a market hub. You have more information. You have trust. You have a reputation. And people end up doing deals through you in the long run.
A lot of wisdom involves realizing long-term consequences of your actions. The longer your time horizon, the wiser you’re going to seem to everybody around you.
Envy can give you a powerful boost, or it can eat you alive
Nivi: Do you want to tell us about jobs you had growing up and the one that kicked off your fanatical obsession with creating wealth?
Naval: This gets a little personal, and I don’t want to humble-brag. There was a thread going around Twitter—Name Five Jobs You’ve Held—and every rich person on there was signaling how they’ve held normal jobs. I don’t want to play that game.
I’ve had menial jobs. There are people who had it worse than me and people who had it better than me.
Suffering through the wrong thing can motivate you to find the right thing
At one point in college I was washing dishes in the school cafeteria and said, “F this. I hate this. I can’t do this anymore.” I sweet-talked may way into a teaching assistant job for a computer science professor, even though I was completely unqualified. The job forced me to learn computer algorithms, so I could TA the rest of the course.
So my desire to learn computer algorithms came out of the suffering I experienced washing dishes—not that there’s anything wrong with washing dishes; it just wasn’t for me.
I had an active mind. I wanted to make money and earn a living through mental activities, not through physical activities. Sometimes it takes suffering through the wrong thing to motivate you to find the right thing.
Being a lawyer was not what I was meant to do
Back in the day I had a prestigious internship at a big New York City law firm. I basically got fired for surfing Usenet.
This was before the Internet was a big thing. Usenet hosted newsgroups, and it was the only the only thing keeping me from being completely bored. I was an overpaid intern wearing a suit and tie. I got to hang out in the conference room and make photocopies when lawyers needed them.
I was bored out of my skull. This was pre-iPhone (thank God for Steve Jobs for saving us all from unending boredom). I used to read The Wall Street Journal or anything I could get my hands on. I would’ve read the back of a brochure to keep from going insane, because listening to a bunch of corporate lawyers discuss how to optimize details of a contract is really dull.
They wanted me to sit there quietly and not read the paper. They got mad and said, “That’s rude. That’s misbehavior.”
I got called up and reprimanded a bunch of times. I was finally terminated—sent home in shame from my prestigious internship, destroying my chance to go to law school.
I was unhappy… for all of an hour. Ultimately, it’s one of the best things that ever happened to me. Otherwise, I would have ended up a lawyer. Not that I have anything against lawyers; it’s just not what I was meant to do.
Envy can be a powerful booster, if it doesn’t eat you alive
Nivi: You mentioned a catering job that kicked off your obsession with wealth.
Naval: That was an envy thing. When I was in high school, I needed a job to pay for my first semester of college.
It was the summer of 1990 or 1991. This was the Bush Senior recession—if anyone listening was alive back then to remember it—so it was actually really hard to get a job.
I ended up working for a catering company serving Indian food. One day, I had to serve at a birthday party for a kid in my school. So I was out there serving food and drinks to all of my classmates. That was incredibly embarrassing. I wanted to hide away and die right there.
But you know what? It’s all part of the plan. It’s all part of the motivation. If that didn’t happen, I probably wouldn’t be as motivated or as successful. It’s all fine. It was definitely a strong motivator.
In that sense, envy can be useful. Envy also can eat you alive if you let it follow you around your entire life. But there are points in your life when it can be a powerful booster rocket.
Principal-Agent Problem: Act Like an Owner
If you think and act like an owner, it’s only a matter of time until you become an owner
A principal is an owner; an agent is an employee
Nivi: We spoke earlier about picking a business model that has leverage from scale economies, network effects and zero marginal cost of replication. There were a few other ideas on the cutting-room floor that I want to go through with you. The first one is the principal-agent problem.
Naval: So mental models are all the rage. Everyone’s trying to become smarter by adopting mental models. I think mental models are interesting, but I don’t think explicitly in terms of mental-model checklists. I know Charlie Munger does, but that’s just not how I think.
Instead, I tend to focus on the few lessons I’ve learned over and over in life that I think are incredibly important and seem to apply almost universally. One that keeps coming up from microeconomics—because as we’ve established, macroeconomics is not really worth spending time on—is what’s called the principal-agent problem.
In this case it’s a principal, who is a person; rather than a principle that you would follow. A principal is an owner. An agent works for the owner, so you can think of an agent as an employee. The difference between a founder and an employee is the difference between a principal and an agent.
A principal’s incentives are different than an agent’s incentives
I can summarize the principal-agent problem with a famous quote attributed to Napoleon or Julius Caesar:
“If you want it done, Go. If not, Send.”
Which is to say: If you want to do something right, do it yourself; because other people just don’t care enough.
Now, the principal-agent problem pops up everywhere. In microeconomics, they try to characterize it this way: The principal’s incentives are different than the agent’s incentives, so the owner of the business wants what is best for the business and will make the most money. The agent generally wants whatever will look good to the principal, or might make them the most friends in the neighborhood or in the business, or might make them personally the most money.
You see this a lot with hired-gun CEOs running public companies, where the ownership of the public company is distributed so widely that there’s no principal remaining. Nobody owns more than 1% of the company. The CEO takes charge, stuffs the board with their buddies and then starts issuing themself low-price stock options, or doing a lot of stock buybacks because their compensation is based directly tied to the stock price.
If you can work on incentives, don’t work on anything else
Agents have a way of hacking systems. This is what make incentive design so difficult. As Charlie Munger says, if you could be working on incentives, don’t work on anything else.
Almost all human behavior can be explained by incentives. The study of signaling is seeing what people do despite what they say. People are much more honest with their actions than they are with their words. You have to get the incentives right to get people to behave correctly. It’s a very difficult problem because people aren’t coin-operated. The good ones are not just looking for money—they’re also looking for things like status and meaning in what they do.
As a business owner you are always going to be dealing with the principal-agent problem. You’re always going to be trying to figure out: How do I make this person think like me? How do I incent them? How do I give them founder mentality?
Only founders can fully appreciate the importance of a founder mentality and just how difficult and gnarly principal-agent problem is.
When you do deals, it’s better to have the same incentives
If you are a principal, you want to spend a lot of your time thinking about this problem. You want to be generous with your top lieutenants—in terms of ownership and incentives—even if they don’t necessarily realize it; because over time they will and you want them to be aligned with you.
When you do business deals, it’s better to have an aligned partnership where you both have the same incentives than a partnership where you have the advantage in the deal. Because eventually the other person will figure it and the partnership will fall apart. Either way, it’s not going to be one of those things that you can invest in and enjoy the benefits of compound interest over decades.
If you’re an employee, your most important job is to think like a principal
Finally, if you’re in a role where you’re an agent—you’re an employee—then your most important job is to think like a principal. The more you can think like a principal, the better off you’re going to be long-term. Train yourself how to think like a principal, and eventually you will become a principal. If you align yourself with a good principal, they will promote you or empower you or give you accountability or leverage that may be way out of proportion to your relatively menial role.
I’m always impressed by founders who promote young people through the ranks and allow them to skip multiple levels despite their lack of experience. Invariably it happens because this agent—who’s way deep down in the organization—thinks like a principal.
If you can hack your way through the principal-agent problem, you’ll probably solve half of what it takes to run a company.
Nivi: The reason I asked about this one first is because I feel like I never see the principal-agent problem in my work. I tend to work in small teams where everybody is highly economically aligned, and the people have been filtered for a commitment to the mission, and everybody else who doesn’t work out moves on to another role elsewhere.
Naval: These are all heuristics that you have designed to avoid having to deal with the single biggest problem in management.
Deal with small firms to avoid the principal-agent problem
Another example of a heuristic that helps you route around the principal-agent problem is to deal with the smallest firms possible. For example, when I hire a lawyer or a banker or even an accountant to work on my deals, I’ve become very cognizant about the size of the firm. Bigger firms—all other things being equal—are generally worse than small ones.
Yes, the big firm has more experience. Yes, they have more people. Yes, they have a bigger brand. But you’ll find the principal and the agent are highly separated. Very often the principal will sell you and convince you to work with the firm, but then all the work will be done by an agent who simply doesn’t care as much. You end up getting substandard service.
I prefer to work with boutiques. My ideal law firm is a law firm of one. My ideal banker is a solo banker. Now, you’re making other sacrifices and trade-offs in terms of that person’s resources—and you are betting big on that person. But you’ve got one throat to choke. There’s no one else to point fingers at; there’s nowhere to run. The accountability is extremely high.
If you are an agent, the best way to operate is to ask, “What would the founder do?” If you think like the owner and you act like the owner, it’s only a matter of time until you become the owner.
Kelly Criterion: Avoid Ruin
Don’t ruin your reputation or get wiped to zero
Don’t bet everything on one big gamble
Nivi: Let’s chat about the Kelly criterion.
Naval: The Kelly criterion is a popularized mathematical formulation of a simple concept. The simple concept is: Don’t risk everything. Stay out of jail. Don’t bet everything on one big gamble. Be careful how much you bet each time, so you don’t lose the whole kitty.
If you’re a gambler, the Kelly criterion mathematically formulates how much you should wager per hand, even if you have an edge—because even when you have an edge, you can still lose. Let’s say you have 51-to-49 edge. Every gambler knows not to bet the whole kitty on that 51-to-49 edge—because you could lose everything and won’t get to come back to the average.
Nassim Taleb famously talks about ergodicity, which is a fancy word for a simple concept: What is true for 100 people on average isn’t the same as one person averaging that same thing 100 times.
Ruining your reputation is the same as getting wiped to zero
The easiest way to see that is with Russian roulette. Say six people play Russian roulette one time each, and each winner gets 1 billion. Compare that to one person playing Russian roulette six times with the same gun. They are never going to end up a billionaire—they will be dead and worth zero. So risk-taking—especially when the averages that are calculated across large populations—is not always rational.
The Kelly criterion helps you avoid ruin. The number one way people get ruined in modern business is not by betting too much; it’s by cutting corners and doing unethical or downright illegal things. Ending up in an orange jumpsuit in prison or ruining your reputation is the same as getting wiped to zero—so never do those things.
Schelling Point: Cooperating Without Communicating
People who can’t communicate can cooperate by anticipating the other person’s actions
Use social norms to cooperate when you can’t communicate
Nivi: Let’s talk about Schelling points.
Naval: The Schelling point is a game theory concept made famous by Thomas Schelling in his book, The Strategy of Conflict, which I recommend.
It’s about multiplayer games where people respond based on what they think the other person’s response will be. He came up with a mathematical formalization to answer: How do you get people who cannot communicate with each other to coordinate?
Use social norms to cooperate when you can’t communicate
Suppose I want to meet with you, but I don’t tell you where or when to meet. You also want to meet with me, but we can’t communicate. That sounds like an impossible problem to solve—we can’t do it. But not quite.
You can use social norms to converge on a Schelling point. I know you’re rational and educated. And you know I’m rational and educated. We’re both going to start thinking.
When will we meet? If we have to pick an arbitrary date, we’ll probably pick New Year’s Eve. What time will we meet? Midnight or 12:01 a.m. Where will we meet? If we’re Americans, the big meeting spot is probably New York City, the most important city. Where in New York City will we meet? Probably under the clock at Grand Central Station. Maybe you end up at the Empire State Building, but not likely.
You can find Schelling points in business, art and politics
There are many games—whether it’s business or art or politics—where you can find a Schelling point. So you can cooperate with the other person, even when you can’t communicate.
Here’s a simple example: Suppose two companies are competing heavily and hold an oligopoly. Let’s say the price fluctuates between 12 for whatever the service is. Don’t be surprised if they converge on $10 without ever talking to each other.