Lincoln's blog

[ Home | RSS 2.0 | ATOM 1.0 ]

Mon, 26 Aug 2013

What's Your Hourly Rate?

It's not uncommon that we need to decide whether to spend some money to save some time. Order food delivery and pay a delivery charge / tip, or travel to the restaurant yourself? Hire someone to build my Ikea furniture, or do it myself? Get the $240 high-power microwave that will last 5 years and saves you a minute a day, or the $40 slow one? Take the $80k job that's only 15 minutes away, or the $100k job which has an hour commute each way?

In this post, I don't have any particularly strong conclusions, but I'm going to go through and analyze a bunch of examples, in hopes that one of the techniques I present can come in useful in your own life.

We can run the back-of-the-envelope calculations. It'd take me 20 minutes to make the trip to the restaurant and back, and the delivery charge is $2. If my hourly rate is over $6/hr, I should order, all else being equal. Building Ikea furniture might take 3 hours of my time, but the builder only costs $25/hr and is a faster builder so she'll do it for $60. So if my hourly rate is over $20/hr I should hire someone. The fast microwave lasts 5 years, saves me 6 hours a year and costs $200 more, so if my hourly rate is more than $7/hr then I should buy it. The commute is an interesting example which I'll save to analyze later, or you can do it yourself before reading my analysis.

Take a look -- the important question with these calculations are all "what's your hourly rate?" Yet we observe many well-paid people taking the "do it yourself" / "cheap" option despite having hourly rates above the threshold. Are they all being irrational, or what's going on here?

Let's get the clear rationalizations out of the way: yes, I know you might enjoy building Ikea furniture or getting a walk outside. If this is your objection, just modify the examples appropriately to remove the enjoyment from the task -- e.g., you've already built three identical pieces of Ikea furniture today; it's drizzling outside so the walk won't be enjoyable.

Okay, here's a real objection: "I would build the Ikea furniture on the weekend, and I don't work weekends, so it's not substituting for paid hours." Here's my rejoinder: are you completely insensitive to time on the weekends? Aren't there some things you would rather do than others? Let's say some old friends are in town -- how much would you spend to be able to hang out with them instead of building furniture? Probably a lot, right? I would claim that most people usually have things almost that cool that they could do with that time, and they just usually don't try very hard to come up with a better use of time before deciding to build the furniture.

My second rejoinder to the above objection: just because you are getting paid such-and-such dollars per hour doesn't mean that's what your free time is worth. Free time can be worth more or less than a job. Here's the definition I'm going to use in order to make this clear: your "free time" rate is the lowest amount of money you would charge to do an arbitrary boring (not pleasant or unpleasant) task for an hour.

The corollary to this definition: If someone is willing to pay you your "free time" rate for an hour of work, no strings attached, you should probably take their offer, because you can find a way to get that hour back for cheaper (e.g., by buying a nicer microwave with the money). Contrapositively, if you regularly find yourself turning down such jobs, you are either acting irrationally, or your free-time wage is higher than you initially thought it was.

Okay, another objection: The microwave doesn't save me time, since I'm not fully occupied while waiting for my food to cook, and so I could read Twitter on my phone. I would have done this anyway to procrastinate at some point during the day, so I just "moved" that time, I didn't save it.

I think this objection has merit, but I don't always go through my whole Twitter feed during the day, and might go a whole day without reading Twitter, so if that happens I did waste that time. So maybe we should value blocks of time differently according to their "shape" -- longer blocks are more valuable, because you can get into a focused state, or travel out of your house, or whatever, and more gets done with that time.

Next question. I don't have a lot of money, and there seem to be a lot of time/money tradeoffs trying to get my dollars. It would cost me my whole savings to upgrade my microwave, stove, knife set, dishwasher, and then I'd be out of money to hire the cleaning staff, furniture-building staff, grocery delivery staff, and so on. Where do I stop? Why pick the microwave over these other things?

I'm not quite sure. One possible answer: "this is what savings is FOR, and you should spend your money in the most effective way you know how, which probably means buying the things that give you the best value in time-for-money. With the time you save, you can get another job and earn back the savings, which can then be reinvested into your time..."

But, you say, savings is useful for a lot more than simply reinvestment. You can pay emergency medical bills, you can send kids through college, buy a house, save for retirement, or other useful things which take large chunks of money. Okay, but let's talk about these. I don't have kids, don't intend to buy a house or car, and am reasonably healthy. Emergency medical bills, in the chance they arise, can go on credit cards (or, in the worst case, I can declare bankruptcy). Should I be saving for retirement, though? A lot of people seem to recommend this. But it's unclear if this is a good idea, because I'm trading off against time now -- and it seems pretty likely that time now is more useful.

There must be other uses for large piles of savings: Traveling, angel investing. Or, if you're a different kind of person, perhaps you'd spend your extra cash on strippers and cocaine. I'm sure there are a ton of expensive valuable things which I will bucket into "Everything Else". I'd guess that someone like me would probably do well with $2-10k in savings. Figure out what your optimal savings account size is, and beyond that it seems like savings is pretty well spent on things which save lots of time. (Don't forget that you could also be donating large amounts of money to effective charities. I am not including that option in this analysis, mainly because I'm focused on time/money tradeoffs here.)

OK, I want to go back and analyze the commute example from the top of the post. I'll repeat it here -- let's say you work a high-tech job at $100k/yr, or $50/hr, and that you commute 1 hour each way to get there. Let's also say you chose this job over a lower-paying nearby one -- $80k/yr ($40/hr) with a 15 minute commute, and assume the jobs were otherwise equally attractive. You're paying an extra 90 minutes a day for an extra $80, so the value of your free time must be under $53/hr. Actually, it's much worse than that: in the US, the marginal tax rate at these salaries is quite high (~25%) so you're really only taking home an extra $60 for your time. So choosing the higher-paying job actually only makes sense if the (observed) value of your free time is below $40/hr.

This brings me to the last point I would like to make, which is that the hourly rate you're actually getting paid isn't tied that closely to the value of your free time. In fact, it's neither an upper nor lower bound. I'll give some more examples: let's say you're a lawyer making $150/hr. But your firm only has so much work to give you, and you have a lot of kids who will need to go through college, and not much savings. You are probably going to value adding to your savings over saving time in the short term, and so you'll bother to drive 40 minutes to the grocery store to save $20 on groceries -- the value of your free time is not more than $30/hr despite your high salary.

On the other hand, let's say you're an entrepreneur working 50 hours a week at a current salary of $15/hr because your company is barely funded enough to pay you even that much. But you're the leader in a fast-growing market, and a huge piece of the potential value of your company comes from remaining the market leader over the next year. Hammering out the assumptions: let's say the hours you work over the next year contribute equally to remaining the market leader, which would make the difference between a $70M company and a $100M company. Let's say you own a third of it and do a third of the work - so the marginal value to you is $10M over the next year, divided by 7500 hours worked (by all three of you) in the year. This comes out to your free time being worth at least $1333/hr. Which means you should spend a lot of energy figuring out how to sustainably get more than 50 work hours in a week :)

Feedback on this post -- corrections, suggestions for improved analyses, and so on, are very much welcomed. (By email: lincoln / techhouse.org)

posted at: 01:54 | path: /rationality | permanent link to this entry