When I look around my peer group (10 year old MBAs/engineers), I see most of them well-settled in high paying jobs, living comfortable lives most other people can only dream of. They live their lives in as low risk a mode as it gets. Their jobs and cash flows are secure, and would most certainly come every month without any hiccup. Even in the rare event of their company or division being laid off, they would be in another job in no time at all. But, as with any low risk activity or strategy, the benefits are pretty linear (say, an x% salary increment every year or a slow grind up the hierarchy every 2 years).
Now as far as their investments are concerned, most of them buy a house or land or put it all in a fixed deposit. Again, all of them bunched up in the low risk end of the spectrum with linear, predictable, low benefits.
As in the financial derivatives market (call and put options), life also gives ‘options’. Now, what’s an option in the financial derivatives market? An option contract offers the buyer ‘the right but not the obligation to buy or sell the underlying asset’ at a pre determined price at a future date. Now, why is this an insanely interesting instrument in the derivatives market? Because, it gives one an opportunity to enter into a contract with outsized future benefits with very little cost or future loss. I know the cost today and that is the maximum I would lose. But, I keep my options open for an unexpected, big exponential benefit. Think insurance contracts, which works like an option in case of an unexpected bad event or outcome. If everyone buys insurance contracts to protect against big downsides, why aren’t enough people buying ‘options’ that gives them outsized benefits with very little cost for them?
Mr. Taleb calls it a barbell strategy in life. Think of a barbell with weights on both ends. Similarly, you are more benefited if you combine low risk, more certainty, low benefits on one end of the barbell, with high risk, more uncertainty, high benefits on the other end (think – investing in bitcoin with a high paying stable job), with nothing in between. This is as opposed to being in the middle of the barbell, with mediocre benefits and middle of the range risk that doesn’t even give you certainty (think – investing in debt funds with an uncertain low paying job).
But the most important thing to note here is that one should only buy options that doesn’t cost much. Don’t go out building a power plant on debt when on a salary. That neither a cheap option nor gives outsized benefits soon enough.
What are some cheap options with outsized benefits that grow exponentially?
1. Start an online business
2. Write a book
3. Go to parties
4. Invest in higher risk alternative investment funds
5. Invest in art/bitcoin/sports memorabilia
Some barbell examples:
1. Working in the government and writing a book
2. Clerk moonlighting as an Uber driver (tons of serendipity in the latter)
3. A VP in a bank investing in a momentum derivative fund
4. Owning a commercial rent paying property, and working in a low salary high ESOP startup
What’s not a barbell:
1. A start-up employee trying to build his own business on the side (both on the upper end of risk)
2. A clerk investing in only debt funds (both on the middle end of risk with mediocre benefits)
3. A highly paid tech engineer buying only govt bonds and FDs (both on the low risk, predictable low return end)
So, there are multiple ways to play the barbell – be it in investments or in life. Being a risk averse individual does not mean that one cannot/shouldn’t engage high risk activities. The only thing one should make sure is that particular activity should present a possible outsized benefit and that the cost of the option isn’t high. The odds remains in your favour that way. One shouldn’t do a wheelie on an airport runway just because it’s a high risk activity. Neither the benefit is high nor the odds are in your favour, along with the possible outcome of complete ruin!
Are there any other interesting ways by which you are trying capture optionality in your daily lives? Do let us know in the comments below!