You don’t realize how much people actually make in finance until you work in the industry. Yes, sure you can make around six figures at some of these fortune 500 corporate finance role or be an investment banking analyst making close to $200K a year just a year out of undergrad, but that’s not where the real money is made in finance. It’s not even close to how much the big players in finance make.
There are a few sectors within finance where people with just a few years of experience can make mid six figures or even millions. I know there are probably people reading this blog who have absolutely no idea how much some of these 20-year-olds make and are probably saying I have no idea what I am talking about. Trust me, I was once like you (about me) and knew nothing about finance careers in college or even a few years out of college.
I’ve been in this industry for over a decade now and I’ve seen it all. I’ve seen the classic investment banking Vice President make over $700K in 2021 during the greatest year ever in investment banking, and on the other end of the spectrum, I’ve seen 40-year-old hedge fund managers make $40 million.
$40 million??? Yes, I am not lying. Keep reading below and I’ll walk you through how that is even possible.
There are only two ways of making obscene amounts of money in this world:
- Start your own business
- Have ownership stakes in businesses
Sure, anybody can make a good living being a doctor or a lawyer or an investment banker where you can make ~$200-500K per year a few years after you finish with your studies, but you hit a ceiling very quickly unless you start your own practice (aka start your own business).
To make real money you need to own equity, an ownership stake, in something. Ownership is everything. Without ownership, you will never make a lot of money. You will be a salaried employee for the rest of your life capped at best at mid to high six figures every year.
Now there is nothing wrong with mid to high six figures. That is a boat load of money compared to the average annual household income in the US of ~$70K. For the vast majority of my life, I always thought that anywhere above $200K a year was a ton of money. You can be very comfortable in most suburban towns in the US with that much money. But that is nothing compared to how much you can make when you have ownership of a business.
Why does ownership matter so much?
Think of the two completely opposite ways to make money:
- Exchanging your time for money
- Passive income
Exchanging your time for money. This is where you work and get paid a fixed amount by the hour. The more hours you work, the more you get paid. Now this is the worst way to make money. There is only so much time in the day so you are capped at a set amount of money every single day. Sure, you can get to the point where you are some hot shot lawyer or doctor and can charge a thousand dollars an hour, but you will always be a slave to work in order to make money. If you don’t work a given day, you won’t make any money.
On the other end of the spectrum, passive income is the best way to make real wealth. Sure, you have probably heard of this dozens of times across the internet, but being able to make money by sitting on your ass is undoubtedly the best way to make money, and also the best way to get extremely rich.
Passive income is scalable. It doesn’t depend on time. And the one thing that all passive income sources have in common is ownership.
How does working in finance give you ownership or passive income?
In finance there are sellside jobs (i.e. investment banking, equity research, etc.) and buyside jobs (private equity, hedge funds, venture capital). In virtually all sellside jobs you are capped at how much money you make. Unless you are an amazing salesperson or networking and can bring in a ton of business, you will be capped making mid to high six figures at the peak of your career.
The upside in buyside jobs is completely different. In those first few years on the buyside you won’t be making much, but 5 to 10 years into your buyside roles is where the real money starts to come in.
Why do buyside jobs offer unlimited upside?
This goes back to our point on ownership. The amazing thing about working on the buyside at a private equity firm or hedge fund is that you don’t need to start your own business to get an ownership stake. Working at one of these types of firms lets you indirectly have ownership stakes in numerous businesses all at once through a beautiful thing called carried interest.
That’s the beauty of investing. You invest in businesses that generate returns 24/7 without you having to work at all. Over the long-run these businesses generate cash, pay dividends and become more and more valuable overtime.
How much can you expect to make working at buyside vs. sellside jobs? See below:
- Investment Banking Salaries and Bonuses
- Private Equity Salaries and Bonuses
- Hedge Fund Salaries and Bonuses
What is carried interest?
Carried interest is a simple concept that exists only in the finance world. It is basically a cut of the profits you earn for your investors.
Let’s look at the economics of a typical private equity firm. Say a private equity firm has $1 billion of capital from other investors to invest over an ~8-year time period. That money is not your money, it is given to you by investors to manage. In return for managing this money, investors agree to give you ~20% of the profits if you meet a certain return requirement (usually 6-8% per year).
Let’s assume the private equity firm invests that $1 billion and doubles its money, so profits are $1 billion. The owners of that private equity firm literally keep $200 millions to themselves. And its not like these firms have hundreds of employees; you can run $1 billion of capital with just 5-15 employees.
Now of course the owners of that private equity firm keep the vast majority of that $200 million, probably around $160 million give or take and $40 million gets split up amongst the rest of the team.
Why do these firms get to keep so much of the profits?
It’s very simple. There is so much demand out there to manage money. Every single day, more and more money gets created. Governments around the world are printing trillions of dollars a year out of thin air running massive deficits. It is a guaranteed fact that a decade from now, there will be trillions of dollars more out there in the system for someone to manage.
Now who is going to manage all this money? Sure, a lot will go to the classic long only funds like Blackrock and Fidelity, but given there is so much money out there, there will always be demand out there for “alternative investment vehicles” like private equity firms and hedge funds. Especially those that can show consistent levels of good returns.
There are definitely funds out there that do not make good returns and charge ridiculous fees for doing so. Overtime, these firms will go away. But if a fund can at least make market returns net of fees in an uncorrelated manner (i.e. that doesn’t depend on whether the overall market goes up or down), then why wouldn’t all these pension funds, endowments, and institutions give these funds their money?
Carried interest payments take time to materialize
The problem I see with any young mid 20s buyside kid is they expect to make a lot of money very quickly. They don’t have the patience or the stamina to stick to one industry or one venture for a long period of time. What I have found is that real wealth comes in stages. You can go 3 years, 5 years or even 10 years without make life changing money then all of the sudden your net worth goes up 5-10 times (read net worth by age for those in finance). But if you leave before your carried interest or equity vests, constantly bounce around industries or firms, none of those payments will materialize.
Unless you got lucky and made a killing on cryptocurrencies or investing in some friend’s startup, there is no quick path to wealth. It takes time doing the same thing day in day out for multiple years before you see any progress.
There is always an element of luck involved in making money
Carried interest is worthless if you work at funds that don’t consistently generate good returns. A large number of private equity and hedge funds out there are basically levered to the market and don’t have a meaningful “edge.” Every fund will tell you they aren’t, but in reality, most funds depend on valuations going up over the long-run. It’s tough to differentiate between the winners and losers because the market has gone straight up over the past 50 years.
The reality is luck has a big role to play in whether or not a fund generates good returns. Each fund has its own strategy, industry/asset class focus, and these come in and out of style every decade.
For example, the 2010s were a period where valuations of technology/software/growth-oriented companies grew exponentially. Any fund that invested in these industries, regardless of whether they were smart or not or picked the best investments, made a boat load of money. A rising tide always lifts all boats. Now good times don’t last forever. Different asset classes or investment styles are favored in different investing environments and there is not much you can do about it other than joining funds that have successful track records over long periods of time.
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Quick Update on the Blog
It has been well over a year since I posted on this blog, so apologies to all my old readers who enjoyed all the finance content and advice over the years. 2020 to 2021 was one of the busiest moments of my life. You can imagine how busy it was working at a hedge fund at a time when everyone thought the entire world was heading to a depression due to COVID.
That said, Buyside Hustle is back in business now. We will post content on a regular basis going forward. If there is anything you wish to learn more about in finance or have any questions in general, feel free to comment below.
