The Affordable Loss Principle: Generate Opportunities With More Upside

Building something great is the by-product of small, calculated bets. There are inherent risks involved with each one, but most of the time we neglect the small choices. It's the bigger decisions that the risks become clear to us.

Should I take this job? Start this business? Invest in this company?

Naval Ravikant claims that 90% of his investments go to zero or return the original money he invested. This isn't a good track record. The best entrepreneurs and investors talk about seeking out "asymmetric opportunities", which makes the metric of a 90% success rate irrelevant.

As an angel investor, Naval has invested in companies like Twitter and Uber. His investment in Twitter has returned around 400x and Uber has returned him over 4000x.

Investing it the easiest way to illustrate this principle of taking "asymmetric risks" because money is an easy scorecard. Let's say:

You invest $10 in 200 companies for a total of $2,000. Of these 200 companies, 90% of them fail and go to zero. Leaving you with $200 invested and 20 companies that return money. If you're Naval, Twitter returned you $4,000 (which already doubled your money) and Uber returned $40,000. The $1,800 you lost isn't something that you're worried about anymore.

The average person cannot take the risks of angel investing, nor are they an accredited investor to qualify themselves as one. That doesn't mean asymmetric opportunities aren't available to you in other areas.

The affordable loss principle is a powerful tool to test opportunities.

It's human nature to see an opportunity and start evaluating the upsides, driven by our built-in optimism bias. Unless your an extreme pessimist, it's easy to ignore the worst case scenarios. 1 in 2 people will develop some form of cancer during their lifetime according to NHS, but it's easy to believe it's not going to be you.

Expert entrepreneurs do the inverse removing the bias from their decision making. Rather than thinking about all the returns an opportunity will bring they consider what they're willing to lose in time, money, energy, and effort.

The affordable loss does not depending on the business. It's completely contingent on your risk taking levels as a person.

Last year I got a 64% return in the stock market. When I put money into that account I did so with the thought that I would lose it all. Instead of basing my investments on predictions it allowed me to invest in areas that I saw massive upside in. Working in AI, I thought this area was the future and decided to invest vertically across the industry which has now taken root and provided better optionality for the future. I invested the money expecting it to go to zero instead of trying to defend it if the value was in decline by reallocating my investments.

The affordable loss principle is a way to protect your peace of mind.

By focusing on the downside and setting a clear bottom you gain back mental bandwidth to create. I have watched entrepreneurs invest large amounts of time, money, and effort into their businesses only for the value to be zero. Instead of cutting their losses they continue to try make something happen from it. This only robs them of their time more and causes them to lose more in the end.

Most of the mistakes early entrepreneurs make come from omission, by not paying attention to the loss they're willing to afford when getting started.


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