216. Thinking in terms of consequences
“I learned to embrace risk, as long as it was well thought out and, in a worst-case scenario, I’d still land on my feet.” — Eli Broad
A week ago, a friend called me seeking a specific advice on investing. His dilemma was whether to continue with his equity investments, what with so much uncertainty around — caused by things like Trump tariff flip-flops, potential India Pakistan war etc. After my usual disclaimer — I do not really know how future is going to unfold — I went ahead with my views. When we look back at history, black swan events, i.e., events that happen rarely, are real and they do tend to happen, albeit rarely. However, there are different kinds of black swan events — COVID-19 pandemic was a black swan event, Ukraine-Russia war is a black swan event, Global financial crisis was a black swan event, world wars were black swan events and there are a number of other examples. While each of them may happen rarely, the likelihood of one or the other black swan event happening at any given moment is not that rare. That is why we tend to see at least one black swan event every five years or so. So, as opposed to worrying that a specific bad scenario may materialize, it is better to expect that some bad scenario will happen every few years and prepare for the consequences accordingly. In his case, I asked him not to invest short-term money — i.e., money that he may need within four or five years — in the stock markets.
“One thing that makes it possible to be an optimist is if you have a contingency plan for when all hell breaks loose.” — Randy Pausch
My personal investment philosophy is entirely based on making peace with worst-case scenarios. All of my main investments are within a small number of small cap stocks. This means that my investment portfolio goes through wild gyrations. I expect volatility will always remain high. Given this and the fact that I do not make any active income, I have set aside ten years’ worth of expenses in safe liquid funds. This “large” conservative allocation gives me enough time to shape up and get back to a job, just in case a “great depression” type situation comes up in future. Besides, just because I’m retired, I do not let my skills go blunt. I keep them sharp and for good measure, I have also added more relevant skills to my quiver. But the real power that my large conservative capital allocation bestows on me is not the downside protection but that it allows me to fully realize my risk potential. I’m able to make sufficiently large capital allocation to sufficiently high-risk assets such that I give myself a real shot at wealth creation.
What do I mean by thinking in terms of consequences?
“If we are wise, let us prepare for the worst.” — George Washington
When facing a situation, I try to determine the range of future scenarios possible and prepare for the worst-case among them. In this sense, I tend to take a pessimistic view of the future and prepare for it. In almost all situations, the likelihood of the worst-case scenario actually materializing will be very low — many times, materially lower than the likelihood of the best-case scenario. Preparing for the worst-case scenario does not mean I am pessimistic in my general outlook. I invoke pessimism only to determine what the worst-case scenario could be. Once I have accounted for it in my plans, I take on quite an optimistic attitude while executing my plans. I believe that good things do happen and orient my efforts and resources towards making them happen. This becomes easy to do because the worst-case scenario is accounted for and pushed away from any conscious attention.
“It does not do to leave a live dragon out of your calculations, if you live near one.” — J.R.R. Tolkien
I faithfully try to follow the adage — “prepare for the worst but hope for the best”. Doing this in practice is not as easy as it sounds though. To be able to objectively arrive at a range of future scenarios is emotionally very difficult. Once a negative scenario is imagined, it may take stranglehold on your mind. As your mind anchors onto a negative scenario, it becomes difficult to aim for the optimistic scenarios. The worst-case scenario keeps gnawing at the back of your mind all the time. This makes it hard to take decisive forward steps towards optimistic scenarios. I think, with diligent practice, one will be able to overcome this and develop a mindset that can hold both the bad and good scenarios at the same time. Beware that even after you develop this mindset, articulating your strategies to the stakeholders of your decisions may not be easy. People do not like to imagine worst case scenarios, lest they may manifest them. You may wrongly be branded as a pessimist.
Bottomline
“Named must your fear be before banish it you can” — Star Wars
In a world where nothing about future is certain, where you can, at best, think in terms of likelihoods, I find thinking in terms of consequences liberating. Once the consequences of the worst-case scenario are baked into your plans, you can have confidence to take on risky steps whole heartedly. You can give yourself license to operate out of your comfort zone. This is important because all meaningful progress happens outside of the comfort zone. In my experience, thinking in terms of consequences requires a strong independent mind and also high tolerance for being misunderstood.
***************************
Thanks for taking time to read this article. In this newsletter, I share my learnings that could help you improve your decisions and make meaningful progress on your goals. I try to share stuff that I have personally experienced or experimented with.
To follow me on LinkedIn, click here
