The Perils of Asymmetry

I didn’t die last month deep frying turkeys. I know you were kinda worried, so I wanted to make sure you knew.

Risking life and limb for a juicier turkey seems an odd decision, but it’s a very good example of asymmetry – there was a very high chance of a nice little win (delicious turkey) and a very low chance of a huge loss (death or house burning down or something).

Symmetry is basically equal parts on either side of something. Here’s a good example of symmetry, since an axis could split the picture into two near equal / identical parts:

Here’s an example that’s not so symmetric. Or asymmetry, if you will:

Symmetry, or its lack, is a key consideration in making decisions. Some decisions are pretty balanced: I can have a hamburger, or I can have pizza. Either one is a winner! Or you and I can bet on a coin toss – the chances are equal, as are the gain / loss amounts, so that’s symmetrical too.

Others are not so balanced, and that’s where things get complicated. Asymmetry abounds as we go through our lives, including – and sometimes especially – our financial ones.

A decision that involves asymmetric outcomes could include the following*:

• High chance of huge gain / low chance of small loss
  I think this is what some folks call “asymmetric risk / return”. The return way more than compensates for the risk, so back up the truck for whatever this opportunity is.
  Examples: I can’t think of many. Maybe buying a Tony Robbins book? (Just checked with Tony. He said “YES!”) Finishing high school? Breathing?
• Low chance of small gain / high chance of huge loss
  Rational humans should avoid these, but who said all humans are rational? You’ll often see these chased by the less clever folks.
  Examples: Taking a selfie at the edge of a building, streaking during a football game.
• Low chance of huge gain / high chance of small loss
  I want a 5x to 10x return, brah!
  Examples: lottery tickets, private equity investments, writing a blog
• High chance of small gain / low chance of huge loss
  This is what I want to talk about today. These exist all around us, but we sometimes ignore how the very rare but huge loss can still actually happen.
  Examples: deep frying a turkey, many others below.

Even back in caveman time, there was a little asymmetry to daily decisions.

Caveman decision: Should I eat this new thing?

Outcome 1: It could be yummy and help nourish me.
Outcome 2: I’m dead.

We evolved to make quick decisions with imperfect information, and we were pretty successful at that. One of the reasons, though, is that we used shortcuts. Those same shortcuts and cognitive biases don’t serve us quite so well today.

Our world is far more complex than that of our caveman forebears. We don’t have time to stop and accurately gauge all of the risks around us. So we often just ignore them.

An Example of Asymmetry

For an example, let’s take a hypothetical Millennial. Let’s call her “Piper” (I’ll also allow “Jayden” if you want it to be a boy). Piper is doing something absolutely awesome on her phone – texting, perhaps? – and she is also walking (Piper is quite the talent). She’s just reached a road she needs to cross.

Should she:

1. Excuse herself with apologies and tell her bff she’ll be back in a jiff? OR
2. Keep texting as she crosses the road?

It seems like a simple decision, but there’s a lot going on with Piper, and I’m not talking about the unfolding text drama (aweso! get 2 c my bf 2nite / lylas / cul8r).

Rather, she needs to balance the incredible value of maintaining her uninterrupted text stream and adding to the annals of human knowledge with the higher (potentially much higher) risk of being hit / killed as she crosses the road (omg g2g!). A very low probability event, even with the texting-odds boost.

And to be clear: this is not a knock on Piper. If Piper saw a saber-toothed cat that was threatening to eat her, I think she’d drop the phone and make a great snap decision (fight or flight). It’s the long-tailed low probabilities like being hit by a car when you cross the road that are harder to properly process.

The Peril Is Increasing

In addition to our inherent cognitive biases, there are also some modern factors that further complicate decision making:

• Leverage
  There is a massive magnifier often in place for today’s actions and outcomes. Exhibit A: your life can be ruined by a tweet. Think about that. A <140 character message could ruin the rest of your life. Your caveman DNA thought you were just yelling it across the cave, and now the whole world wants your head.
• Time
  Back in the day, we’d be worried about today, tonight, and maybe tomorrow. Now, we make decisions with multi-year or multi-decade implications, and our brains aren’t wired to do that easily.
• Complex & Conditional Probabilities
  The decisions and probabilities we face today are much more complicated than those of our distant forebears. PhD’s in Statistics can still struggle with probability, particularly for very complicated scenarios, and most of us aren’t quite at that level.

Super Fascinating Stuff. But What Does This Have to do with Finance?

A bunch! Correctly understanding serious imbalances in outcomes is very important in making financial (and life) decisions. Let’s consider some examples:

• Should I reply to that snarky work email and give him what-for?
  On the one hand, it could make me feel a little better and bring some justice to the world.
  On the other hand, it could get me fired.
• Should I text and drive?
  On the one hand, I may move my entertainment meter up a notch and find out what’s going on with Piper.
  On the other hand, I may be dead or (worse) kill someone else (added bonus is losing everything you own).
• Do I really need to get a will?
  On the one hand, I can skip it and watch more TV and eat more Cheetos.
  On the other hand, I might be handing my loved ones a major estate Charlie Foxtrot if I die early.
  (But actually this is a trick question – everyone already has a will.)
• Should I write covered calls? (sorry, just wanted a nerdy finance reference)
  On the one hand, I’m getting a nice little income boost. Boom!
  On the other hand, I’m kinda undermining my chance for a home run. Oh and the theory behind stock ownership.
• Do I have enough money to retire?
  On the one hand, I want to stop working and may have enough saved up.
  On the other hand, I may run out of money.
  Saving too much is a nice problem to have. Saving too little is a disaster.
• Should we have kids now, or should we get established in our careers and have them later?
  On the one hand, we’d have more money and stuff. And money is downright awesome.
  On the other hand, we may not be able to have kids.

The last example is a particularly relevant one today. I think a lot of couples want to get financially established before having kids, but there are incredibly complex and conditional probabilities at work in that decision. I haven’t reviewed anyone’s decision tree for delaying having kids, but I suspect it’d be a little thin on the details.

Decision Analysis Is Just Getting Started. Let the Celebration Begin!

Understanding asymmetry in outcomes is really important to make excellent decisions. I wanted an introduction and ready reference as I tackle some of the more important financial decisions – and their asymmetric outcomes – later this month and year (life is all about having things to look forward to). There\’ll be more to come, and soon!

 

I know I’ve only touched on many deep topics here – if you have thoughts to add to the discussion, or good examples to shore up some of the ones I’ve introduced, I’d love to hear in the comments.

 

 

 

* If you felt shortchanged by my matrix of chances and outcomes, I’ve included the balance below. These are the ones with more symmetric outcomes.

• High chance of huge gain / low chance of huge loss
  Example: Getting immunized.
• High chance of small gain / low chance of small loss
  Example: Choosing the right sandwich at Subway.
• Low chance of huge gain / high chance of huge loss
  Example: Not sure on this. Perhaps proposing to someone early in a relationship at a major sporting event?
• Low chance of small gain / high chance of small loss
  Example: Maybe going to see a Seth Rogen movie nowadays.

 

Symmetrical picture courtesy of GAD-BM

Not-so-symmetrical picture courtesy of ol\’ LoggaWiggler