The Optionality Approach is a follow-up to How to Make Your Own Luck (you don’t need to read it beforehand).
We’ve established that there is no such thing as cosmic justice: it rains on the just and the unjust alike. But over the course of a lifetime, we at least vaguely shuffle in the direction of getting what we deserve. The goal of this post is to get us from ‘vague shuffling’ to ‘slightly-more-purposeful ambling’.
If you want to get lucky, the usual advice is that you have to be prepared, and then wait for opportunities.
This is not very helpful, because there are already way too many opportunities to choose from!
Life involves navigating a labyrinth of forking paths, long corridors, beckoning doors, and intriguing possibilities. Which way to go? Which paths to avoid? Which doors to unlock?
Instead of wandering aimlessly, opening doors that seem promising and hoping for the best, we can use a simple framework to figure out which opportunities are worth pursuing.
This is a filter I run over pretty much every decision these days, called the optionality approach.
UPDATE: My book, Optionality: How to Survive and Thrive in a Volatile World is available now!
Optionality, Risk, and Luck
In Constraints that Liberate, we introduced a simple definition of optionality: the right, but not the obligation, to take action.
But that doesn’t mean all options are equally attractive:
If your crippling student loan debt effectively makes you an indentured servant, the fact that you can choose between 43 brands of cereal for breakfast doesn’t give you much in the way of optionality. If you’re in prison, and the guards sometimes let you choose what to watch on the telly, same again. The quality of choices matters.
Collecting high-quality options is the equivalent of unlocking doors that open up new sections of the map, and might lead to rare Treasure Chests: say, a financial windfall, a new close friend or loved one, a job offer, a successful business, an excellent investment opportunity, a life-changing idea or epiphany. In other words, all the things we associate with ‘good luck’.
Unfortunately, most of our time and attention is consumed by trying to choose between endless variations of low-quality options. Consumer capitalism is designed to give the illusion of great choice, even while it leads us deeper into the labyrinth—wasting our precious time and attention, and distracting us from making the decisions that really matter. These low-quality options are the equivalent of Dead Ends. They sometimes lead to modest rewards, but it’s a lot of effort for not much in the way of loot.
If you hit a dead end, at least you can retrace your steps. But sometimes you open a door that you’ll never walk out of again. These are the high-risk options which have a small chance of sending you tumbling into Bottomless Pits of Doom: addiction, financial ruin, ideological death spirals, disease or disability, accidents, a house fire, an investment that blows up. In other words, all the things we generally associate with ‘bad luck’.
How do you know what’s behind each door?
Dead Ends, Treasure Chests, and Bottomless Pits of Doom each have their own distinct set of attributes, which means we have a decent chance of identifying them before we step through. What we’re looking for in each case is an asymmetry.
I first came across the concept of optionality in Nassim Taleb’s Incerto series. Taleb began his career in the financial markets, where he traded in real-life options—contracts which give you the right (but not the obligation) to buy or sell at a fixed price, within a certain timeframe.
Taleb made his fortune by purchasing options that had a limited downside if they didn’t work out in his favour, but a large, open-ended upside if they did. He was happy to accumulate a lot of small, manageable losses most of the time, then make the occasional killing from rare but high-magnitude events.
These sort of options display a major asymmetry between risk and reward. The downside is always capped—there’s no chance of blowing up—while the potential upside is unlimited.
Taleb’s model suggests that we should be perfectly happy to wander through doors which quickly turn out to be dead ends, if there’s even a small chance they lead to a Treasure Chest. By contrast, we shouldn’t waste precious resources on the ‘safer’, well-travelled doors which only hint at a modest return on investment: we’re looking for a big, uneven payoff, or nothing at all.
Most importantly, we have to resist the allure of the doors that sometimes lead to a Treasure Chest, but occasionally cast greedy adventurers into a Bottomless Pit of Doom.
Even if, like me, you have no interest in option trading, this model from the world of finance carries over beautifully to just about every area of life. Let’s look at a few concrete examples.
Bottomless Pits of Doom
Bottomless Pits are the worst kind of options to pursue. There’s an asymmetry between risk and reward, but it’s in the wrong direction: the upside is fixed, and the downside is unlimited.
That doesn’t necessarily mean you’ll tumble into the pit—it’s enough that there’s any risk of total ruin, no matter how slim.
The classic example is a game of Russian Roulette. You have a chance of winning a few hundred or thousand dollars, but you also have a one-in-six chance of blowing your brains out. The potential rewards are capped; the potential loss is infinite.
I don’t know anyone crazy enough to literally play Russian Roulette, but we make choices with this kind of asymmetry all the time:
The upside of riding motorcycles is that it’s fun, and maybe you save some money on gas. But the chance of ruin is through the roof: the fatality rate is 30 times higher than traveling by car, on a per-mile basis. The risks and rewards are hugely asymmetrical.
Colombian taxi fares
When I walk home from the bar late at night, 99 times out of 100 I’ll be fine. But that one time something bad happens, maybe I get hurt or killed. So I’m happy to absorb a small fixed cost, in the form of paying a few pesos for a taxi fare, to protect against an unlimited downside.
Some recreational drugs have a decent risk-reward payoff. The ones I would steer clear of are those with any prospect of overdose, psychotic break, or addiction. No doubt those drugs are fun, but they’re not infinitely fun.
The poor souls who took out second mortgages or loaded up their credit cards to buy Bitcoin at the peak of the boom were effectively playing Russian Roulette. They spun the barrel, and they lost. By that point in the bubble, the upside was limited: the best they might have hoped for was a measly 1.5x or 2x return. And the downside was unbounded: not only because there was nothing stopping the whole thing collapsing, but because they borrowed money to ‘invest’.
Not being insured
If you venture out onto the roads without insurance, you’re spinning the barrel. Chances are nothing happens, but if you prang someone’s Jaguar—or worse, get served with a personal injury lawsuit—it might be ruinous. Same goes for failing to insure your income, your life (if you have a family to support) or any other irreplaceable asset.
Insurance is very much like an option contract: it lets you pay a small, fixed cost to get exposure to massive upside (or in this case, protect against massive downside). The rewards of not taking out insurance are capped: you get to save some money on premiums. But the risks are bottomless.
Most options don’t display a major asymmetry between risk and reward. The downside is limited, and so is the upside. That means there’s no prospect of horrible losses, but they also don’t give you any exposure to life-changing opportunities:
Moonlighting for Uber
You gain a modest source of extra income in exchange for your time and initial investment. There’s no chance that driving for Uber will make you a millionaire, and there’s no risk that it will bankrupt you (assuming you have insurance). Any side-hustle which boils down to ‘doing more hourly work’ fits into this category.
Most publicly traded companies are mature businesses. Unlike startups, there’s very little chance that you’re going to get a 10x return on investment, and almost no chance of a 100x. Instead, you’ll probably earn modest returns, in return for taking modest risks.
Actively picking stocks adds more downside than upside, because most active investors perform badly, while passively buying an index fund reduces both upside and downside—you’re only ever going to match the average return.
The upside of America’s number one pastime is limited: you get to enjoy some light entertainment, but it’s unlikely to change your world. The downside is also limited: it’s a huge time-suck, and interferes with sleep quality, but it doesn’t literally rot your brain.
There’s nothing inherently wrong with options that fall in this middle ground. Driving for Uber might be a good choice for some people, investing in boring index funds is probably the right strategy for most of us, and watching TV is fun.
‘Dead Ends’ is probably too harsh a name for this class of options, but it does point at something important: the danger of these middling paths is that they lead you away from making the kind of decisions that open up life-changing opportunities.
These are the sexy asymmetries that lead to major life changes. There’s no guarantee they’ll actually pay off—and most of the time, they won’t. But if you collect enough of these open-ended options, you’ll have a much better chance of getting ‘lucky’.
Here are a few examples:
If you can sell a product or service over and over again with little or no marginal costs—say, software, music, art, books, or digital products—you’re no longer bound by the linear returns of driving for Uber.
Of course, this is really frickin’ hard, and the rewards are unevenly distributed: a tiny proportion of artists, creatives, and entrepreneurs capture almost all the value. But it does create an opportunity for unbounded upside.
If you send a well-crafted email introducing yourself or asking for a piece of advice from someone you admire, the worst that happens is you don’t get a reply. The potential upside is in making a connection with someone who might be able to change your life.
A related asymmetry: giving praise. I recently realised I’ve been following some people’s work for years, and never once let them know how much value I got from it. If I do speak up, it’s more likely to be to correct an error, or disagree with something.
Now I’m making an effort to reach out and say thanks. This costs me all of three minutes, and I know from personal experience that a small word of encouragement at the right time can have a huge impact.
Venture capital-style investing
Some of my portfolio is in early-stage private companies with huge potential upside. They’re unlikely to succeed, but if even one of them takes off, it’ll be life-changing.
Meanwhile, the downside is capped: I’ve only allocated so much money to that side of the barbell, and expect most of them to fail (I don’t necessarily recommend this approach, but it is a central example of optionality).
Meeting new people
Lots of social events are ‘meh’, but so what? The downside is minimal: maybe a couple of hours which I probably would have otherwise spent goofing off at home. And the potential upside is huge.
For example: I hosted some Couchsurfers at my apartment a few years ago. Most of them were pleasant enough: we hung out, then went our separate ways. But I really hit it off with one American, who told me I had to meet her boyfriend, and invited me to a retreat later in the year. I bought a ticket to India on a whim, immediately clicked with her boyfriend, and became involved in a project which is now one of the most promising irons I’ve got in the fire (besides the very rewarding project of our friendship, which also brought me to San Francisco and into the orbit of a whole new crowd of interesting people).
A lot of my best relationships have weird origin stories like this. These days I try to deliberately create space for serendipity to strike: whether it be hosting strangers, going to relevant meetups and parties, or visiting cities which are focal points for interesting people.
Books might be the most amazing asymmetry of all: for a few dollars (or sometimes for free) you get to hang out with the smartest and most interesting people who ever lived.
Most books aren’t worth reading. But the downside is fixed, so it doesn’t matter! You can bail out as soon you realise it’s a dud, and you’ve only wasted ten bucks.
That’s an incredibly cheap option to take out, because every once in a while, you find a quake book which turns your world upside down upside. Reading books has enriched my life immeasurably, for a total cost of less than $1000! (I will instantly 10x this figure if I ever settle down long enough to build a personal library.)
Specifically, resistance training (e.g. lifting weights or calisthenics). The downside is limited to the time cost of 2-3 hours a week, and maybe a little discomfort to begin with.
In return, you open an upside so huge that it’s essentially unbounded: improved metabolic health, protection against accidents, stronger bones and tendons, insulin sensitivity, longevity, better quality of life, mental health, more energy, a halo effect, and then all the downstream effects of these things on your productivity, career opportunities, dating etc.
This is such a no-brainer that I think it’s awesome how meathead gym culture has started crossing over into the mainstream. Do u even lift, bro?
Pick a Door, Any Door
This is not an exhaustive list. I only wanted to give enough examples so you can get a feel for the framework, and think about how it might apply to your own opportunities: is the downside capped? Is the upside unlimited?
The optionality approach doesn’t give you the ability to predict the future. You still can’t be sure what lies behind each door, because there’s always an inescapable element of randomness. That’s why it’s so important to have some kind of coping mechanism for when the universe screws you over.
But the comforting thing about having optionality is you don’t have to be able to predict the future. You make a calculated decision, grasp the handle firmly, and step through each doorway without hesitation. There’s no need to know whether any individual venture will work out.
Instead, you just keep hunting for these asymmetric opportunities, wherever you can find them. Eventually—over the course of a lifetime—hopefully some of them will pay off.
Yeah, but are we all gonna make it?
How’s your startup investment looking these days BTW? (Does it depend on ads? That’s probably a risk in the medium term.)
yeah, none of my portfolio companies have ad-based revenue models, they’re SAAS or licensing-based. Some of them have already returned 5-10x, which makes my IRR look amazing, but means very little on paper. Companies that take VC funding tend to have pretty binary outcomes – if they make it all the way to IPO (typically 8-10 years) I will do very handsomely on that side of the barbell, and if they don’t, I will make approximately $0!
Yeah, that’s good. SAAS in particular is a great business model, though (of course) bootstrapped is preferable to VC-funded if at all possible. Good fortune to you. (I bet you’ll come out pretty well.)
Hey Richard – I really value your writing and these kinds of mental frameworks are very helpful to me. Curious about these investments…how did you gain access to them and how might i invest in something like that? I’m comfortably invested in index funds and some real estate, but I’d love to start a moonshot fund.
Hey R B, thanks, glad to hear it!
Obligatory disclaimer: I think this style of investing is a bad idea for most people (myself included), because it’s extremely hard to get access to high-risk investments that aren’t junk. For my part, I’ve done it through:
b) early-stage listed growth companies
d) investing in companies started by people I know personally.
Taking each in turn: crowdfunding is neat, but also implies that the companies who raise money aren’t good enough to pass muster with actual VCs. I’ve written about this here. Looking at it through the optionality lens, there isn’t much of an asymmetry to exploit.
Publicly listed companies are usually more mature, so it’s unusual to get a 10x and almost unheard of to get a 100x. I have had mixed experiences taking ‘punts’ on listed growth companies, and wouldn’t recommend buying into the hype of e.g pre-revenue IPOs. Related thoughts here. Again, there’s no asymmetry to exploit, unless you’re looking for stocks in unusually illiquid or obscure markets (but even then, I’m not convinced you can escape the EMH).
Cryptocurrencies are fraught for obvious reasons, and probably past the opportune time for the really big (e.g. 100-1000x) returns. There was an information asymmetry to exploit back when only a handful of finance and crypto geeks knew about this obscure ‘Bitcoin’ thing, but it sure as hell doesn’t exist any more.
Investing in friends’ startups is fraught too. But at least there’s actually some kind of information asymmetry to exploit (maybe you know them well, you can fund them before they raise money from professional angels and VCs, etc). But it still requires connections to entrepreneurial circles, the possibility of relationships souring, and the ability to evaluate a deal – that last factor being a highly specialised skill that real VCs spent a lifetime learning, have countless exclusive pitches coming across their desk, and STILL don’t necessarily do all that well!
On paper I am doing really well from this strategy, but I did a lot of dumb shit, probably got lucky with the things that happen to be working, and might still come out empty-handed in the end. So there you have it! Don’t mean to be dispiriting but I think it’s important to be honest about this.
Thank you for the framework!
I can’t help but notice that many of the bottomless pit style options are recognizably Cool(TM). I mean the classic risk behaviors like taking drugs, drinking, driving a motorcycle, crossing a natural ice bridge without safety gear, etc. In my childhood it was considered uncool to wear a seat belt. And this is of course a feature not a bug, for these bottomless pit behaviors are costly signals of one’s health and capability. We cannot eradicate them by pointing out that they are dangerous; the danger is what makes people do them. All I can suggest is to be very aware if and when you are about to engage in a dangerous display activity, to make sure that this is really the best thing for you to do in the situation. For it has to be the best thing for some people sometimes, otherwise it wouldn’t have evolved?
That’s a great observation, hadn’t made that connection! Being Cool(TM) is definitely a costly signal, but I would guess that it probably misfires a lot of the time in modernity. e.g. cigarettes, heroin, motorcycles were not exactly features of the ancestral environment. The occasional feats of courage and derring-do make a lot more sense, because they’re one-off or sporadic events, rather than a daily lifestyle practice. If you cross an ice bridge without ropes once you’re a badass; if you don’t wear a seatbelt every day you’re a road fatality statistic.
I think one Treasure Chest idea is smart career selection. It may not be equally available to everyone but if you’ve got the brainpower to become an engineer or a medical specialist and the talent to rise to the top, making millions is child’s play. At the very worst if you fail to achieve corporate officer level or end up as a general practice doc you’ll still make six figures. So the worst case is still pretty good.