# mundell

There is a disconnect between payoffs and probabilities. People don't understand the difference between the two and which one you should value more. A payoff is a return on an investment or bet. Probability is the likelihood of something happening.

What we are looking for is asymmetric payoff opportunities. This means that the potential payoff from being right outweighs the negative effects of being wrong. A simple example is preparing for a natural disaster, let's say a hurricane. Nobody knows exactly when a hurricane is going to occur, although they are more likely from June to November. But the potential benefits (payoff) from preparing for a hurricane are large. Ensuring you have extra rations, a generator, a safe location to stay, and a plan ahead of time can potentially save your life. The money spent on these items is trivial when compared to the value of your life or home.

We should live our lives thinking about the consequences of events, rather than the probabilities of them. Look at the potential return on investment behind a bet. Probability and payoffs need to be considered together since gambling your life savings on a 1 in 10,000 bet is practically guaranteed to lose although it offers a massive return. You want to find an arbitrage in investments. Does Option A give you 3x higher return than Option B for only 5% less risk? If yes, invest in Option A.

The common analogy is the “picking up pennies in front of a steamroller” vs bleeding a little bit each day on your bets in hopes for a large payoff. This is hard to do because it hurts more to lose money than it does to gain money. Not many can endure the emotional toil caused by losing some money everyday. Watch or read up on The Big Short. It's a story about the 2008 financial crisis. Michael Burry bet his entire firm that the housing market would collapse. Leading up to the collapse he was losing a lot of money each day and had to reassure investors and hold the course. When the market collapsed he and his firm received a massive return on the bet, although to an ordinary person the probability of the bet working was low (hint: it wasn't).

Some advice for your own life is this: suffer small losses each day, hoping for a big win instead of gaining a small amount each day but exposing yourself to blow-up risks. This can be easily done by spending time producing rather than consuming. Producing costs a small amount and gives you unlimited upside. Even if you fail you will be able to learn from your mistakes and try again. Consuming makes you feel good while you're doing it, but you're never actually improving.