A Bimodal Approach to Risks in Life

Bimodal Approach

Image from Seeking Alpha – http://seekingalpha.com/article/2843836-profiting-from-market-randomness

I’m currently working my way through reading the book Antifragile and thought I’d share some of the insights I’ve gained from it. One particular concept has stood out to me so far is the idea of a bimodal approach to risks in your life, AKA ‘the barbell technique.’

What does bimodal approach even mean?

A fair question. So bimodal means by 2 methods or approaches. This is where the barbell nickname comes in. Imagine a barbell with weights on either side. This is bimodal because there are 2 weighted sections with the bar in the middle.

So how does this apply to risks?

The book explains early on that humans are notorious for miscalculating the risk of a situation except in the extreme cases when it is really obvious. This being the case it is suggested to concentrate your life on 2 types of activities, those with very low risk and those with high risk which also have a very high possible return and then pretty much nothing in between.

If most of your life activities are low risk with no downside but only moderate benefits then you will be quite safe from most disasters. In my mind this focuses on activities such as walking (low risk while providing slight health benefits), saving money in cash (again low risk while providing a slight interest appreciation) and other daily habits like brushing your teeth (no real downside to brushing your teeth with the upside of less dental issues).

The problem with these low risk activities is that they are generally not likely to provide large rewards. No one ever became a multi-millionaire by saving money in cash. No one ever gained a super fit physique by walking alone. So to pursue some of these large rewards the second area we should focus on is activities which promise a high return even though they may carry higher risk.

In the book the author uses the phrase ‘unbounded upside’ to refer to the small possibility of a very high return on the activity. You also want to make sure that these risks have a bounded downside, ie. they won’t completely destroy you. Some examples of these kind of activities might include heavy weight lifting (somewhat high risk of injury but also a high benefit to your health) and calculated risky business ventures (these will almost always have a higher possible return. The trick is to not over invest!).

The key point is to look for activities that have lots of potential to be beneficial to you while also not risking everything on these activities.

But why no moderate activities?

As we mentioned humans are not good at estimating things except in extreme cases where the risk is obvious. So at least with low risk or high risk activities we are likely to actually know what we are dealing with. The problem arises with moderate risk activities. Activities such as investing in the stock market are moderate risk activities or at least they appear to be.

Lets examine stock market investing in a bit more detail. We think of it as a historically moderate risk and moderate return activity. History shows an average of 7% yearly return over the long term. The danger comes from the potential for crashes which could wipe out large amounts of your profit. And unfortunately these stock market crashes are impossible to predict with any accuracy. So we have the possibility of large losses with only a moderate return. As such the author is advising it might be better to look for other alternatives.

Summary

Overall I’m personally not convinced of the need to remove moderate risk activities from my life. I feel that even though there is some risk it is still beneficial for the potential gains to be had, even if those gains are moderate by definition.

It’s interesting to think about things from a different angle and I appreciate the reminder to be on the look out for activities with large potential benefits. We could all be a little bit more observant when looking for these activities.

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