Optionality by Richard Meadows is a Taleb-esque exploration of how to navigate an uncertain and volatile world. The basic premise is that we don’t need to predict the future, but that we should seek out optionality – small, strategic bets or choices that could have asymmetrical rewards in the future. That is: a low downside, but a potentially high upside.
It’s a good synthesis of the concept and the book provides a clear framework on how to think about optionality, not just in terms of finance or investments, but also in other domains of life.
For more details and reviews go to Amazon.
If you’re interested in the applications of optionality also check out my article Optionality as a Mental Model.
Book Summary & Notes
All text between quotation marks is taken directly from the book.
What is optionality?
Optionality is “the right, but not the obligation, to take action”. What is important is the asymmetry between the cost of the option, and the potential upside (there are also negative asymmetries, like addiction to drugs or consumer debt – no rights, only obligations). Insurance is a basic example of optionality, but it only prevents disaster and there’s no upside.
Even though we have a lot of options to choose from in daily life, they normally don’t carry asymmetrical outcomes. Instead, they’re usually consumer-capitalist choices: we choose from what’s available, rather than creating our own options.
“Generating better options is much more important than being a perfect decision maker.” But this also carries a risk: if we never exercise any options, we end up with a lot of maybe’s and no action.
Mediocrity is often the result when we try to maximize everything at once. For example when buying expensive consumer goods and pursuing early retirement at the same time. But there’s also a flip side to this: if we try to achieve some future goal by minimizing everything in the present, we simply trade one set of choices (consumerism) with another (extreme FIRE ideologies).
Meadows writes that the best ways to open up options in life is to either have more money or require less of it. This gives autonomy and freedom.
“This increase in optionality happens along two dimensions at once. As your desires become simpler, less work is required to meet your expenses, which gives you more time and freedom for other pursuits. At the same time, your growing stash of cash is opening doors. With enough money, you walk can walk right out of a crappy job. You can seize an unexpected opportunity that comes your way. You can build up enough seed capital to start a business. You can earn passive investment income. You can begin to redesign your life in a manner that pleases you.”
Types of options
Meadows lists three types of (asymmetrical) options:
- Bottomless pits of doom: negative asymmetry. Meaning: low (fixed) potential upside, unbounded downside. Examples: Russian roulette, addictive drugs, motorcycles, cybersecurity.
- Dead ends: no asymmetry in either direction, fixed downside and fixed upside. Examples: Uber as a side hustle, individual stocks, watching TV.
- Treasure chests: positive asymmetry. Meaning low (fixed) downside, and high unbounded upside. Examples: scalable side hustles, books, messaging strangers, venture capital-style bets.
Lifestyle inflation: “The all-consuming nature of lifestyle inflation underscores the importance of first ruthlessly min-maxing for the things that are actually worth having. If we try to maximise everything at once, we’re doomed to pound long on the hedonic treadmill forever, and end up going nowhere fast.”
Four factors of optionality
- Financial capital: safety buffer (protecting downside), investments or starting a business (opening upside).
- Social capital: support network (protecting downside), network effects (opening upside).
- Knowledge capital: basic skills such as cooking and fixing things (protecting downside), marketable skills or credentials (opening upside).
- Health capital: preventing disease and accidents (protecting downside), a force multiplier for other domains (opening upside).
Not everyone can be at the top of their field, but using optionality increases your chances of (modest) success. In real life, winning is often about not losing. Risk accumulates in the background so making an effort to avoid this and not losing means you’ll do better than average. Protecting the downside always comes first.
The Matthew Effect: “For to every one who has, more will be given, and he will have an abundance. But from the one who has not, even what he has will be taken away.” This is why it’s crucial to have momentum on your side. Having debt leads to more debt, but investments have positive momentum. The same holds true for health, popularity and power as well.
Out of the four factors, financial capital has the highest utility (but the lowest meaning): it can be exchanged relatively easily for the other forms of capital. So wealth is not an end unto itself; it’s better to see money and wealth “as an option on the good life: it can be used to buy back freedom, to spend time with loved ones, to lever us into more fulfilling work, to eliminate stress and negative influences, to broaden our skills and interests, and to change the lives of the less fortunate.”
“To a surprisingly large degree, we are our own jailers. Continuing to play negative-sum status games and stacking up material possessions past the point of diminishing returns makes about as much sense as banging your head against a brick wall.”
Goals are not always positive. In fact, they may even work too well and can lead us astray in a few different ways.
- It can lead to tunnel vision – we miss opportunities and threats along the way. The classic mistake is focusing on a career and building wealth and forgetting meaning, family, et cetera.
- Goodhart’s Law: “when a measure becomes a target, it’s no longer a good measure”. Based on the story of bounties for dead cobra’s in India which led to a well-run cobra-breeding industry.
- Onanism: having clear goals and a clear vision, and telling the world about it, can lead to a failure to distinguish between reality and imagination. Talking about a thing is often negatively correlated with doing the thing.
- Prediction errors: what if the starting point for our goals is wrong? We have to work with imperfect information, in an imperfect and uncertain world.
This does not mean that optionality equals keeping options permanently open, not setting goals, and drifting through life. It simply means that there is a time to create options and a time to exercise them. You don’t have to make complicated predictions – rather, you focus on a few things, protect yourself from losing, and recognise favourable circumstances when they occur. In the end, it’s better to be vaguely right than precisely wrong.
Terminal vs. instrumental goals: The first is something we want, the latter is something that will help us move closer to what we really want. The first is motivating, the latter measurable. For example: start a business (terminal), save $50,000 in seed capital (instrumental).
Making specific goals or plans usually results in failure – it’s inevitable that our intentions get thwarted. But using optionality means have different goals and plans that are spread out across a wider domain, the failure of one option will not destroy the entire system. If the current option does not work out, the next one might, or the one after that. It’s a system-oriented approach rather than a goal-oriented approach.
Habits and automation
“Success spirals probably don’t ‘increase’ your willpower, so much as rewire your expectations. Your brain is a giant prediction machine which constantly makes guesses about the state of the world, compares it against the raw data coming in, and then recalibrates itself accordingly. If you consistently follow through on your intentions, your brain revises its predictions of success upwards. Over time, this becomes a self-fulfilling prophecy: if you start to believe you’re capable of doing hard things, that’s half the battle won.”
Not all domains work for automation, the key is to focus on domains that have little variety and don’t change over time. So there’s no need to experiment past a certain point.
Social reality is the shared hallucination of people – it’s in the stories we tell each other, and the dominant narrative. But there’s not just one social reality; if we want to seek out a different narrative, we will found groups of people who believe in different hallucinations. We can deliberately seek out those groups that have skills and behaviours we want to learn or imitate.
There is a risk though in joining a certain group narrative: when it starts to define your identity. There is a form of ideological path dependency that is hard to escape from, and you need to retain your independence.
Asymmetrical options in the financial domain
Which things are worth the expense, and which things should we go cheap on? Meadows states that we should buy quality for the things we use every day (computer, smartphone, knives, tools) and things that lead to risk of ruin (safety gear, contraceptives, fitness equipment). In the middle of these areas are the things ‘between you and the ground’, such as shoes, beds, and tires.
Main lessons from financial capital asymmetries:
- If you own too many things, it closes off options (true costs are often hard to estimate)
- If you can get the value of a depreciating asset by renting or leasing it, then that’s better than outright owning it
- Well-being can be improved by setting your expectations low and looking for experiences that could have a surprise – a high upside.
- To prevent hedonistic adaptation create artificial scarcity in ‘positive’ experiences. Meaning: don’t take an expensive vacation every month, and save the good bottle of wine for a celebration.
- Option value can be found on the road less travelled, if you go where everyone else goes then the risks are low, but the benefits as well.
- There is a trade-off between personal enjoyment and external signalling. Brand-name products and experiences usually lead to the latter; so beware of playing status games you don’t want to play.
Asymmetrical options in the health domain
Main lessons from health capital asymmetries:
- Good health means the absence of problems. There’s only so much upside when it comes to health, but the downside can be enormous.
- While death ends all options (obviously), disease and disability also destroy it. But for most people, the biggest issue is the silent accumulation of risk due to lifestyle.
- Drugs, diets, supplements, novel exercise regimens are usually dead ends: the benefits are modest at best, they don’t have asymmetrical rewards.
- In health capital, there are many opportunities for automation. It’s stable, and so when you know what works for you, make it a habit and stop experimenting (if you don’t want to).
Asymmetrical options in the social domain
Attention is asymmetrically divided: famous people receive the lion share of praise or attention which means they are unlikely to respond or help us socially. But ‘getting in on the ground floor’, by backing talented people who are not yet famous, can result is potential big upsides. “Place your chips early, stand behind your friends, and shill for the unshilled.”
To exploit these asymmetries you need to create serendipity. This is usually very cheap, with a low downside (just the initial time investment), and could potentially lead to major results. Examples are events, special interest groups, and coffee meetups. This is the opposite of networking events where everyone is trying to gain some benefit. So decide what type of people you want to meet, where you can find them, and, after that, it becomes a numbers game to get serendipitous results.
Social media is a tool and, if possible, should be used to build meaningful connections. Meadows advises to move away from proximity to the average user, and customise and min-max the connections to build meaningful relationships. Stay inside a bubble because most social media is toxic.
Main lessons from social capital asymmetries:
- Friendships are conditional, if you have toxic people in your life you need to get them out, or at least keep your distance.
- Lindy effect also applies to relationships: invest in the oldest ones first.
- You can secede into your own bubble of like-minded people, especially with social media this avoids toxicity and being outraged by things that are not important.
- Become part of an ecosystem (“scenius”), and if not possible try to meet or get exposed to as many tribe members as possible.
- Use the internet: blogs, Twitter and email all expose you to people you never could have met before.
- But don’t spread yourself too thinly, always focus more on your closest relationships.
Asymmetrical options in the knowledge domain
Meadows argues that for the average person it’s much better to pursue generalism than specialism. “Without certain blessings – genetic or otherwise – it’s impossible to push the cutting edge of most specialised fields. But if you find a way to combine your modestly competent skills, you can excel in an entirely new niche of your own making.” This plays into Scott Adams’ talent stack idea: combine a few skills you’re better at than the average person, and you will gain a unique mix of value.
Reading books is probably the cheapest option available, and we should treat it as such. If there’s no asymmetrical reward to be found, then skip it, skim it, and don’t feel obligated to finish every book you start. There’s also a difference between active and passive reading. Passive reading means your knowledge will degrade and not compound, hence you need to use the knowledge and ideas you’ve read and have a system such as a commonplace book or a personal knowledge management system.
Main lessons from social knowledge asymmetries:
- There’s a massive amount of passive leisure time that could be allocated to more fruitful pursuits.
- Building general competencies protect against downsides and uncertainties, since the more you can do yourself, the more resilient you are.
- That doesn’t mean that every skill is worth pursuing – you can make an estimation by taking the value of your time, the costs of acquiring the skills and looking at the potential upside to determine if it’s worth learning or not.
- While reading can lead to compound payoffs it needs to be active, not passive. So store your knowledge, use it, and refer back to it.
Hunting for Black Swans
While the famous advice from Paul Graham is that the best bet to get rich is to join a startup, this has increasingly become a marketing ploy. The terms of stock options are more unappealing, there’s share dilution, and stock options often cannot be liquidated until some unknown point in the future.
So what are some Black Swan opportunities then? There’s speculation in assets classes that you know but that are not popular yet, angel investing in sectors you are familiar with, buying a growing business or portfolio of businesses, taking equity in a startup (but only if you can get good terms), and investing in yourself: learning new skills or buying your own time to work on side projects.
Meadows is not a fan of active black swan hunting since most options are not available to everyone. Instead, he prefers a birdwatching approach: follow your own motivations, learn skills, develop your talents, take an interest in what’s happening and let serendipity strike.
Exploring & Exploiting
In the end, it’s not about creating options, but about exploiting them. But how do you know when to explore and when to exploit? There’s no simple solution for this, but it depends on 1) the timeframe – if you have a lot of time available it’s better to explore more, and 2) the volatility of the domain – if nothing changes, then there’s no need to explore more options and you can simply start exploiting.
There is such a thing as premature exploitation when people reach a ‘local maxima’ but due to the lack of exploring they miss the ‘global maxima’. An example of this is focusing and specialising early in your career; the salary might be higher but you miss exploring other areas and building skills and connections there.
In domains where there is little volatility specialisation wins, but where volatility is high and diversification useful generalism wins. It’s also not a dichotomy: you can be a specialist in one area, but a generalist in many others. Or you can do it sequentially: explore, specialise for a while, explore another area, et cetera.
Effectuation: “the logic of causal reasoning is that to the extent that we can predict the future, we can control it. The logic of effectual reasoning is that to the extent that we can control the future, we don’t need to predict it.” Effectuation starts with an inventory of resources and skills you have available and based on that set a goal or create options.
Saras Sarasvathy’s four principles of effectuation:
- “Bird-in-hand: Create solutions with the resources available here and now”
- “Lemonade principle: Mistakes and surprises are inevitable and can be used to look for new opportunities”
- “Crazy quilt: Entering into new partnerships can bring the project new funds and new directions”
- “Affordable loss: You should only invest as much as you are willing to lose”
Meadows argues that traditional employment is increasingly insecure. We all have to start to become more entrepreneurial, think in non-linear options, protecting our downsides, profiting from volatility, and creating multiple income streams.
Critique on optionality
Meadows argues that the most vocal opponents of optionality already have more than enough options in their life. These critics include Peter Thiel, venture capitalists, and finance professors. They are outliers and don’t need to focus on creating options, because due to their background and experience they can move in many different directions. For most people though, this is simply not true.
Interested in Optionality? Get the book on Amazon.