At first glance, this idea might sound absurd. Most people are well aware that teachers earn far less than investment bankers—on paper.
You might think: “Teachers might make $100,000 at the peak of their careers, while investment bankers can easily earn 10 times that—or more—with salaries and bonuses. How could they possibly be paid the same?”
Yet, when we step back and consider the full picture of compensation, including unseen factors like transaction costs, the comparison becomes much closer. This article explores how these hidden costs—and the choices people make to accept or avoid them—help explain the disparity between these two professions.
About the author: Jeff Hulett leads Personal Finance Reimagined, a decision-making and financial education platform. He teaches personal finance at James Madison University and provides personal finance seminars. Check out his book -- Making Choices, Making Money: Your Guide to Making Confident Financial Decisions.
Jeff is a career banker, data scientist, behavioral economist, and choice architect. Jeff has held banking and consulting leadership roles at Wells Fargo, Citibank, KPMG, and IBM.
The Role of Transaction Costs in Work Compensation
Many people believe that teachers earn significantly less than investment bankers because they focus solely on visible monetary compensation, such as salaries and bonuses. This perspective often overlooks the hidden costs associated with working in a particular profession. In economics, this unseen burden can be understood as transaction costs—the non-monetary sacrifices workers make to participate in a specific labor market.
In this context, think of transaction costs as the “hidden price” a worker pays for their job, beyond what is reflected in their paycheck. And as we’ll see, these transaction costs play a crucial role in explaining the disparity in pay between investment bankers and teachers.
The Transaction Costs of Being an Investment Banker
Becoming and working as an investment banker entails significant transaction costs. These are the unseen burdens—financial, personal, and lifestyle-related—that come with entering and succeeding in this high-stakes profession. While their salaries may appear astronomical, the sacrifices required to earn them often go unnoticed. These costs play a critical role in determining why such high pay is necessary to attract and retain talent in the industry. These include:
Specialized Education Investment bankers often require rigorous academic preparation, typically in finance, math, economics, or a hard science. Advanced certifications like the CFA demand additional time and resources. Not everyone is willing—or able—to pay this price.
Geographic Constraints Investment banking jobs are concentrated in large, high-cost urban hubs like New York, London, and Tokyo. Living in these cities involves financial and lifestyle sacrifices that many people would prefer to avoid.
Performance Pressure Investment bankers face relentless performance demands. Failure to meet targets can result in dismissal—a high-stakes environment not everyone is equipped to handle.
Risky Compensation A significant portion of an investment banker’s pay is tied to bonuses, which are contingent on hitting performance metrics. This variability adds financial uncertainty.
Work-Life Imbalance Investment bankers often endure grueling schedules, frequently exceeding 100 hours per week, particularly during high-pressure periods. This lack of personal time represents a substantial transaction cost.
Case Study: Sarah, the Teacher Considering Investment Banking
Sarah, a dedicated high school teacher, finds herself frustrated by her modest salary. She’s drawn to the idea of transitioning into investment banking to significantly increase her income. However, as she begins exploring this path, Sarah faces a stark reality: the transaction costs are high.
To switch careers, Sarah would need to return to school to pursue an MBA or specialized certifications like the CFA, requiring years of study and tens of thousands of dollars in tuition. She’d likely need to relocate to a major financial hub, such as New York City, where the cost of living is drastically higher than her small-town life. Furthermore, the demanding work hours—100+ per week during peak times—would mean sacrificing evenings and weekends she currently spends with family and friends. After weighing these costs, Sarah realizes that while the salary of an investment banker is tempting, the lifestyle trade-offs may not align with her values and priorities.
The Transaction Costs of Being a Teacher
In contrast, teaching comes with much lower transaction costs. These are the less visible benefits—such as greater job security, geographic flexibility, and a more predictable work-life balance—that make the profession more accessible and appealing to a broader range of individuals. While teachers earn less in monetary terms, the lower transaction costs help offset the difference and attract those who prioritize stability and lifestyle over high pay.
These include:
Flexible Academic Pathways Teachers generally require less specialized education, with many paths leading to certification. This lowers the upfront barrier to entry.
Geographic Flexibility Schools exist everywhere. Teachers can often choose where to live and work, avoiding the lifestyle constraints imposed by urban financial centers.
Job Security Public school teachers benefit from tenure protections, which make job loss less likely compared to the high stakes of investment banking.
Stable Compensation Teachers’ salaries are largely fixed, providing financial predictability without the uncertainty of performance-based bonuses.
Work-Life Balance Teachers enjoy structured schedules with holidays and summers off, offering greater opportunities for personal time.
Case Study: Alex, the Aspiring Undergraduate
Alex considered becoming a teacher at first. The structured schedule, summers off, and the opportunity to live wherever he wanted were appealing. He admired the balance teachers seemed to enjoy and appreciated the impact they had on their students. But Alex also recognized that the lifestyle of an investment banker—and the significantly higher earning potential—was even more appealing to him.
Fortunately, Alex had mentors who helped him understand the trade-offs involved in both paths. Some were teachers, others were investment bankers, and their insights were invaluable in shaping his decision. They explained the importance of starting early if he wanted to pursue investment banking, as it is much easier to pivot away from the IB track than to pivot toward it later in life.
Armed with this knowledge, Alex chose to major in finance and worked hard to maintain a GPA above 3.5, knowing it was a prerequisite for top-tier internships. By his sophomore year, Alex was already applying for internships in New York. When he landed one, he quickly realized the transaction costs firsthand: the high cost of living in the city consumed most of his earnings, and the demanding schedule left little room for relaxation or socializing. Despite these challenges, Alex valued the potential long-term rewards and appreciated the guidance that helped him make an informed choice.
Why the 10x Salary Difference Is “Fair”
You might still wonder: “How can such a vast pay gap be equitable?”
The answer lies in the marginal value of transaction costs. Investment banks, operating in a competitive labor market, only pay their employees enough to keep them from choosing an alternative occupation—like becoming a teacher. Every additional dollar paid to a banker is a dollar taken from shareholders or clients, so managers have strong incentives to pay no more than is necessary to offset the profession’s steep transaction costs.
Conversely, teachers are paid what is necessary to attract enough qualified individuals into the profession, given the relatively low transaction costs associated with teaching.
Revealing Transaction Costs Through Choices
Ultimately, people reveal their transaction cost preferences through their career choices. For example, Sarah’s decision to remain a teacher shows her preference for stability, personal time, and geographic freedom over a higher salary with steeper sacrifices. Alex’s determination to pursue investment banking demonstrates his willingness to bear high transaction costs in pursuit of financial success.
The beauty of the market system is that it enables individuals to weigh these costs and make choices that align with their own values and abilities. Salaries are not arbitrary; they reflect the trade-offs people are willing to make.
A Final Thought
Consider Sarah and Alex. Sarah, the teacher, weighed the high transaction costs of transitioning to investment banking and chose to remain in a profession that aligns with her values of stability, personal time, and geographic freedom. Alex, on the other hand, embraced the steep transaction costs of investment banking early in his career, recognizing the potential long-term financial rewards and the importance of starting on the IB path as soon as possible.
Both Sarah and Alex made decisions that reflect their unique preferences and priorities. The beauty of the market system is that it enables individuals like them to weigh these costs—both seen and unseen—and choose paths that best fit their goals and circumstances.
And if they later reassess how they value their marginal transaction costs relative to the marginal compensation opportunities available, they can always choose to change their careers. Sarah might decide the allure of a higher salary outweighs the lifestyle trade-offs, while Alex might determine that greater balance and flexibility matter more than financial rewards. These dynamic preferences underscore the importance of continuously evaluating both the costs and benefits of career choices.
So, the next time a teacher enjoys their summer vacation or an investment banker earns a seven-figure bonus after a grueling 100-hour workweek, remember this: both are receiving compensation that reflects the transaction costs they’re willing to bear. Neither is overpaid or underpaid—they are simply earning what the market has determined is necessary for their choices, now and in the future.
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