Lessons from Adam Smith: Botched Lingo and Paying Yourself Your Due

I have immersed myself in Adam Smith's book The Wealth of Nations recently.  Compared to other books I have read from the 18th century, this is an easy read.  I highly recommend you pick up a copy.  The lessons in it are timeless.

One of the points that he makes in Chapter VI of Book I is about accounting for four components of price.  The components being:

1.  Rent - rent for land or space to produce a good
2.  Wages - money paid for labour
3.  Stock - money used to purchase goods or materials
4.  Profit - money returned to the overseer of the operation as compensation for the undertaking.

He then goes on to address accounts of wild profits being had by farmers in America and the West Indies who farmed their own land:

A gentleman who farms part of his own estate, after paying the expense of cultivation, should gain both the rent of the landlord and the profit of the farmer.  He is apt to denominate, however, his whole gain, [as] profit, and thus confound rent with profit, at least in common language. 

This quote got me thinking.  I suppose the reason Mr. Smith brings up this story is that rumors of wild profit were circulating around England at the time.  Obviously, rumors of riches can cause huge migrations of society (i.e. California gold rush).  He attempts to rebut the excitement created by these stories by saying "What those guys say is profit really isn't profit and here is why."  It's like stories today we hear about homes "cashflowing" when the actual term the unwitting storyteller should be using is "revenue".  There is a huge difference between the two words.   

This quote also got me thinking about the analogy of the farmer of 1776 to today's real estate investor. Lets replace a couple words in the above quote and see if we can get something more out of it:

"An investor who manages his own real estate, after paying the expense of mortgages and upkeep, should gain both the profit of the investor and the property manager."  

So as investors, we need to take into account management of our property as either a profit center or an expense. Since the market rate for property management is 10% of gross rents, investors can find themselves significantly more profitable when managing the property themselves.  However, if we wish to grow our wealth in a way that is scalable, property management becomes unwieldy quite quickly and must, in most cases, become an expense as we pay someone else to do it for us.  It becomes the cost of growth.

Let us learn form Mr. Smith's sagely ways.  Always be accurate in what you speak to others and always be honest with yourself in your accounting books.