Consider two artists: MC Hammer and Chamillionaire. Most people know the former because it went bankrupt in the 90s despite making millions of dollars. This is a good case of a money mistake that many high earners often overlook.
MC Hammer earned $37 million. But he spent 50. And when he filed for bankruptcy in 1996, he was $13 million in debt.
Now let’s look at Chamillionaire, who, like Hammer, was popular for several years. He had a famous song called Ridin Dirty when I was in college. I was never a fan and had never heard of Chamillionaire until a few years ago.
I read that he used the money he made from the few years he was popular to invest. Now he is should at least $50 million.
Enter: extrapolation offset
In the world of behavioral science and finance, there is a concept called “over-extrapolation” or “extrapolation bias”, which refers to the assumption that past returns equal profits (these terms are used interchangeably).
According to one paper by Purdue, Casella and Gulen, “an extrapolative investor believes that recent high returns are likely to be followed by high returns, and similarly, recent low returns are likely to be followed by low returns.”
We strive make the same mistake when it comes to personal finance. It is something that almost everyone is passionate about, be it a writer, an investor, an artist, a scientist, a medical professional, and so on.
If we earn well for a short period of time, we expect the checks to keep coming. To me, this is the biggest money mistake of our career.
MC Hammer spent more than he earned. Why would a person do this? If they expect that they will continue to make money to pay for it later.
But what if the money stops coming?
My experience with an average salary
Publishing platform Medium distributes the revenue they receive from members to their authors. I never paid attention to how they do it, I just focused on writing articles for readers.
In the beginning, there were relatively few writers and many readers. For the first two years, my earnings (or royalties) were in six figures a year. As you can expect, I was very pleased with it.
But I never got carried away. I’ve heard too many stories of internet entrepreneurs who were used to making money on certain platforms…until the platform changed its rules.
Here’s how many Facebook marketers went bankrupt in 2015 and 2016 when the mass migration to Instagram took place. I’ve seen a similar thing with people who were heavily involved in SEO. It worked until it didn’t. Google suddenly changed their rules and these people went bankrupt.
Starting in 2020, more and more writers came to Medium. Naturally, the competition intensified. I the cake had to be shared with more writers.
Salaries have collapsed for many authors, including me. But because I never expected the checks to come in, I never went broke on Medium. I still think it’s a great platform.
Embrace chaos instead of order
I have been very interested in chaos theory for the past few years. The underlying assumption is that life is becoming increasingly complex and chaotic.
Take, for example, the world of economics. Until a few decades ago, economics was largely a matter of supply and demand. The field was full of order and rules, which really translated very well into practice.
These rules no longer apply.
We have made the economy 10 times more complex and unstable through government policies and a shift in psychology from the public (who expect the government to help more) and politicians (who think they should actually help more).
Chaos theory is still a new field, and scientists are intensively researching its applications in various fields.
One thing is certain: nothing is stable. You know how people say, “There are only two things in life that can be said, death and taxes.”
Even taxes are not stable. The amount of tax we have to pay is constantly being debated.
What does this mean for us, the people who are trying to make the best of our individual lives– we can never expect good things to last. I
Although this may sound depressing, it is not. More importantly, we can also expect that bad things will not continue.
Be prepared: the good and the bad
What I appreciate about Chamillionaire is that he didn’t spend his money expecting to be on top forever. He realized that most musicians would not stay popular for long. When things went well and he was making good money, he started investing.
This is an important life lesson that many of us learned from the elders in our family.
The important thing is that we never expect anything to last. Life is in constant motion.
It also means that the bad times will not last.
I am writing this in October 2022 and sometimes it feels like it the problem of inflation will never leave. There are certainly many Nostradamuses predicting the collapse of the West and the dollar.
These people extrapolate. Instead, take a more sophisticated (and balanced) view.
Respect the chaos. Good times don’t last. Bad times don’t last. Life is constantly changing.
And that’s what makes it exciting to be alive.