I want to share a thing with you in this piece that may guide your next couple years. It has guided mine so far as well. So please enjoy the read.
It’s about decision making
A few years ago when I was preparing for my ICAN Professional Exam, I took a course called Strategic Financial Management (SFM).
In SFM there was this topic called Derivatives. A derivative is one nuanced topic in SFM. Because of this, a lot of people tend to shy away from it, but I took a particular interest in it.
One, because knowing it means I will get the opportunity to teach those who don’t know it (never mind me, I like to teach). Two, because intelligence in it matters to me for self-esteem sake.
I took interest in it and became the go-to-person to consult on it. Mission accomplished :)
But that’s not where I’m going. A segment inside Derivative is called “Option.”
In a simple term, an option is a financial instrument that gives you the right, not the obligation to buy a given asset at a given price on a future date.
The implication of an option as a financial instrument is that it allows you to buy an asset for say $100 on a future date even if the asset’s market price is $164.
Invariably, you have an upside of $64 immediately if you exercise the option.
And if the asset’s market price on that future date is $45, you will choose not to exercise an option that allows you to buy the same asset for $100.
No harm! Just do what’s best for you.
What I’ve not told you yet about an option is that it has a price. Basically, for you to have an option, you will pay quite a small (negligible) price say $5 for an option of say $100.
The implication of the option price is simple.
If on that future date, the asset is selling for less than your option gives you a right to buy it, you won’t exercise such right (to buy) and you will lose the $5 (option price).
On the other hand, if the asset is selling for an amount higher than your option gives you the right to buy, you exercise such right and make a massive gain.
Now, from what I’ve described so far, you will agree with me that in this scenario, your maximum loss is capped at $5 while your maximum gain is theoretically unlimited, unbounded.
That was the lesson I learnt from derivative as a result of my fascination with it.
Let’s talk about how that applies. Before that, let me show you a visual representation of what I just described.
I taught this topic passionately to my Professional Colleague and we all finally got qualified as a Chartered Accountant one time or the other (I think I was part of the last batch to qualify).
Much later in life, the subject of decision making and taking bets will become of high priority for me. And I needed to devise a framework for making decisions.
The need to make smart decisions that have potentially unlimited upside and a known and well-defined downside quickly brought to my remembrance lessons from Derivatives.
Ever since I realized that anytime it’s time to make a decision (a bet), I start by accessing the worst-case scenario.
I am usually very objective and particular about my assessment of the worst-case scenario. That’s important because it’s critical for my decision.
If the worst-case scenario of such bet is acceptable, I move on to estimating the potential upside and characteristics of the upside (limited or unlimited).
Knowing those two variables and their nuances, I make decisions.
Now, where has that gotten me?
There are times that I lose. But remember I’ve established that they are acceptable losses. Life is a risk and we must be ready to accept some losses in other to stand a chance for potential upside.
Times of loss doesn’t particularly move me. I just write off my loss.
No angst at all. Of course, there is the feeling of I wished it had worked out. But never a feeling of that was too much a loss to suffer.
But I must say, the few upsides that I’ve gotten over the period has far more compensated for any loss I might have suffered.
That’s the way the principle works remember: Potentially Unlimited Upside
The message I’m trying to get home should be apparent by now.
Decision making is nuance and until you get better at it, you may be stuck in life. In fact, if you make an unwise decision, it will cost you more than you could possibly take. Devastating is sometimes such failures.
I’ve given you a simple framework that can potentially make you a super decision-maker who always win in a big way. Leverage that framework.
If you want to take a bet (not NairaBet please, I don’t encourage that) on a course of action,
- Determine the worst-case scenario under a very strict rule
- Estimate the potential upside its characteristics
- If the worst-case scenario is acceptable, and the upside is unlimited, go forward and take such bets. Otherwise, neglect it or gather more information.
Do that, and I can guarantee that you would be fine over time.