Page 139 - Morgan Housel - The Psychology of Money_ Timeless Lessons on Wealth, Greed, and Happiness-Harriman House Limited (2020)

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An important cousin of room for error is what I call optimism bias in risk-
taking, or “Russian roulette should statistically work” syndrome: An
attachment to favorable odds when the downside is unacceptable in any

circumstances.

Nassim Taleb says, “You can be risk loving and yet completely averse to
ruin.” And indeed, you should.

The idea is that you have to take risk to get ahead, but no risk that can wipe
you out is ever worth taking. The odds are in your favor when playing
Russian roulette. But the downside is not worth the potential upside. There
is no margin of safety that can compensate for the risk.

Same with money. The odds of many lucrative things are in your favor.
Real estate prices go up most years, and during most years you’ll get a
paycheck every other week. But if something has 95% odds of being right,

the 5% odds of being wrong means you will almost certainly experience the
downside at some point in your life. And if the cost of the downside is ruin,
the upside the other 95% of the time likely isn’t worth the risk, no matter
how appealing it looks.

Leverage is the devil here. Leverage—taking on debt to make your money
go further—pushes routine risks into something capable of producing ruin.

The danger is that rational optimism most of the time masks the odds of
ruin some of the time. The result is we systematically underestimate risk.
Housing prices fell 30% last decade. A few companies defaulted on their
debt. That’s capitalism. It happens. But those with high leverage had a
double wipeout: Not only were they left broke, but being wiped out erased
every opportunity to get back in the game at the very moment opportunity
was ripe. A homeowner wiped out in 2009 had no chance of taking

advantage of cheap mortgage rates in 2010. Lehman Brothers had no
chance of investing in cheap debt in 2009. They were done.

To get around this, I think of my own money as barbelled. I take risks with
one portion and am terrified with the other. This is not inconsistent, but the