mundell

Reminders for myself that I don't mind sharing

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.

The things we don’t know are more valuable than the things we do know. Ask yourself, “Do I know who I am and what the world around me is really like?” The answer is no. As we grow older, we learn new things about ourselves and about the world around us. We hold new viewpoints, gain new perspectives.

I’m fond of the idea of an anti-library, although I do feel it’s virtue signaling. An anti-library is having a home library filled primarily with books you haven’t read yet. This is meant to represent the knowledge you don’t know, which is inherently more valuable than the knowledge you do know. It is meant to serve as a reminder to try new things.

I think it’s amazing that world-changing ideas are waiting to be found. The combinations are available and we have what it takes to execute on these ideas, we just need to discover them first. We should experiment more since there is no other real way of discovering them. Before the wheel was invented a group of people didn’t form and say “Let’s create the wheel!” because they would have known what they were looking for, which would’ve meant the wheel already existed.

Innovation must come through random iterations. It's like the saying of how people create their own luck. By consistently taking small risks or engaging in experiments one can find new things and learn more about themselves. I felt similar when I went to college. In high school you are surrounded by the same people, many of which you’ve “known” for 10+ years. Yet when you get to college it’s like stepping into a new world where the quality of your friends drastically increases. You are surrounded by mature, like-minded adults.

How can we encourage risk-taking? By risk-taking I mean venturing into the unknown, whether it is in personal life (meeting new people) or business (starting a business) or something else entirely. We can help it by aligning incentives. Japanese culture regards failed businessmen as failures in society. If we look at failed entrepreneurs as heroes instead it may help spur new businesses. We can also align the incentives by ensuring no blow-up risk. Tell people “Who cares if you lost 25% of your savings chasing a wild idea? You can make it back and at least you didn’t go bankrupt.” That may be harder to get across but it would certainly help.

Something America does better than anyone else is glorify its entrepreneurs. Elon Musk is most notable. He is regarded as a hero, which I’m sure has encouraged people to start risky businesses.

The point I’m trying to get across is this, venture into the unknown because what have you got to lose? We all get one shot at life and there is no use staying within our comfort zone.

Enter your email to subscribe to updates.