A lot of modern-day talk in the business and personal development world is inundated with platitudinous advice and contradictory dogmas that you’re expected to take a side on. This is nothing new. Peddling simple answers to tough questions will always sell more books than telling people that there is no clear-cut path and that a lot of life is simply a balancing act that takes time and energy to figure out.  

Among the most popular dogmas and false dichotomies are: “it’s better to be an irrational optimist than a rational pessimist”, or “work smarter not harder” or “The Obstacle is the Way".

There is no easy path” is something that largely holds true but to assume that no effort can be wasted is equally naive to thinking you can bypass the need to work hard by being “smart”. To make a claim as simplistically formulaic as “The Obstacle is The Way” is also patently bunk when we consider that the reward for any given task is so vastly disproportionate to its difficulty, that the correlation is virtually non-existent.  

For instance, unless people are paying you to do so, trying to beat the market is a fool’s game, given the difficulty of the task, the time commitment required and the measly 2-3% difference in returns when people actually succeed.  Taking a year to learn a trade like plumbing might take a lot of work but when you run the numbers between that and obtaining a 4-year liberal arts degree, you’ll likely find a huge disparity between the median incomes and their associated cost (both in time and money).

It would be interesting to run a regression analysis between a fair metric of “effort” and lifetime earnings or ROI. I’d suspect the disparities to be so large that the correlation would be close to 0, thus proving my point.

The dichotomy between optimism and pessimism is particularly flawed because it all depends on the individual, not their “risk tolerance” (a dumb concept), but rather which side of the spectrum they tend towards. Too much optimism and boldness are what cause people to be naive and get wrapped up in multi-level marketing schemes or purchase overpriced timeshares. Too much pessimism can cripple you from taking action and cause you to fall into a cycle of self-fulfilling prophecies.

For instance, if you’re applying to jobs and you see that they’re looking for applicants with experience you don’t have, the pessimist won’t even bother applying at all, disqualifying themself before the race even begins, despite having virtually nothing to lose. To “air on the side of boldness” would be good advice for this individual but bad advice for the guy who’s feeling tempted by the “business offer” from the old classmate he hasn’t spoken to in years. The latter has stuff to lose.

When navigating your way through choices and opportunities, rather than asking “is it better to be optimistic or pessimistic”, a much better (but deceptively simple-sounding) question to ask is this:

What do I stand to lose and what do I stand to gain from taking this action?  

This question varies tremendously in difficulty to answer depending on what you’re trying to accomplish. Large insurance companies pay big money for actuaries whose sole job it is to answer these types of questions.

This principle holds doubly true for how you should invest your money—a particularly tricky question when factoring in all of the variables.

Of course, you should only invest in what you know and avoid speculative bets. And of course, the average person would probably be better off investing in a few carefully selected index funds and holding cash than they would trying to beat the market.  But even with this approach, there are risks, opportunity costs and externalities to consider. “Playing it safe” is a deceptively tough field to navigate.

We don’t know what the market will look like in 20 years. Are we living in a market bubble? Probably. Is the S&P 500 price overinflated from the fed printing money and holding interest rates at exceedingly low levels since the housing crash? Probably. Will the market continue to grow at a consistent rate of 7-8% a year for the remainder of your life? I have no clue. Will the Austrian’s be proven right and will all this demand-side, modern monetary theory-driven policy cause overexpansion and misallocation of resources that lead to something far worse than in ‘08?  I have no clue.

In light of this, you could choose to buy gold or hold cash.  In this case, by holding cash, it’s guaranteed to depreciate a rate of approximately 2% percent a year, if we go by the CPI. Given that the CPI is a terrible measure of inflation, in that it fails to account for bubbles, grotesquely rising housing costs and (if you’re American) grotesquely rising medical costs; we can assume the rate of inflation to in fact be much higher than 2%.  Holding cash comes with opportunity costs.

[Gold in orange DJI in blue]

In this case, you could buy gold, it might pay off. Gold has consistently outperformed the market since ‘08.

If you’re looking at gold as a hedge against inflation, however, it’s been counterintuitively found to perform rather badly during periods of high inflation (see this article for details). There are no sure things.

The obvious answer, in this case, would be to “diversify” your portfolio, however, this is way more difficult to do than most people realize; in today’s world where the not so free market’s performance is almost entirely determined by the actions of the Fed, simply holding index funds doesn’t mean you’re diversified anymore.  There are no simple answers, this stuff takes homework.

The point is, there are always tradeoffs and there is no one-size-fits-all answer for when to be bullish and when to be pessimistic.  As I said before, much of life is a careful balancing act that ultimately comes down to what you have to gain vs what you have to lose. Understand how probability works and use it to your advantage.  

This is the crux of calculated risk-taking.  Once you grasp this you see that there is no “high” or “low” risk tolerance, only people who understand the probability game and people who don’t.  Again, this doesn’t mean there’s a one-size-fits-all formula, given that everyone is working with different time horizons and disposable income levels but the principle remains the same.  

Knowing what you stand to win and knowing what you stand to lose.