Using The Barbell Strategy to Build Extreme Wealth

Post Last Updated: February 18, 2019

place asymmetric bets to build extreme wealth

Becoming rich in a short amount of time is possible, but you need to bet big to win big. Looking for a big reward requires taking on a lot of risk – but is there a way to minimize your risk and not have to put a lot of money on the line?

This post is all about how to think about investing in terms of bets and asymmetric payoffs.

Can you become rich without needing a lot of money? Is it possible to make a lot of money without risking much money?

When I was 19, my best friend and I loved to go to the casino and play blackjack. A few times a month, we would take a $20 out of the ATM, head over to the casino, sit down at a $5 table, and see how we would do.

Sometimes we came out ahead. One time I won $200. Most times, we both lost our $20’s.

Blackjack is a game in which you don’t have an advantage. It’s a gamble, and not a great strategy for becoming rich with a small amount of money.

Becoming rich and financially free at a young age is one of my goals.

To become wealthy in a short amount of time without having a lot of money, I’ve needed to take on a fair amount of risk with my money. At the same time, I’ve needed to not be stupid and be mindful of where I’m placing that money and my bets.

In this post, I will be discussing the concept of expectation from statistics, talking about risk, reward, and investing, and finally, touching on how you can use asymmetric bets to grow your wealth without having a lot of money.

Note: the following discussion can also be applied to someone’s career, educational path, and seeking higher compensation. With that being said, I’ve chosen for this article to focus on asymmetric bets as they apply to building wealth.

investing for beginnersWhat is Risk?

Risk is a funny concept.

There are so many people who talk about risk like it’s something concrete or tangible.

As defined by Wikipedia, risk is the potential of gaining or losing something of value.

Risk has a negative connotation, but in my opinion, there is good risk, and, of course, bad risk.

To build wealth and become rich, taking good risks is key and can have a healthy payoff.

Before getting into what some of these good risks are, I need to talk about the concept of expectation and the expected value of a situation.

I’m going to do my best to explain this statistical concept in everyday language, so don’t be afraid if you aren’t a math person. ūüôā

What is the Expected Value?

To talk about risk appropriately, I need to talk about the expected value and the expectation of a situation.

Speaking statistically, the expectation of a situation is the average outcome over all potential outcomes.

For example, let’s look at a coin flip.

The expected value of a coin flip is 50% of the time, you should expect heads and 50% of the time you should expect tails.

To go more general, let’s define¬†X¬†as a scenario with outcomes 5, 10, 15, 20, and 100, and all of these outcomes having an equal chance (a 20% or 1/5) of being realized.

The expectation of X is the average value over all outcomes, or putting this into an equation:

E(X) = (5+10+15+20+100)/5 = 30

What happens to the expectation if the chances of these outcomes change?

What if, respectively, the probability of these outcomes become 10%, 20%, 10%, 20%, and 40%?

Then the expected value calculation changes:

E(X) = 5*10% + 10*20% + 15*10% + 20*20% + 100*40% = 48

It is important to understand that not all outcomes in real life are equal.

What is an Asymmetric Bet?

An asymmetric bet is a bet in which the potential upside (earning potential or return in these investing scenarios) is much greater than the downside.

In other words, you might risk a small amount of money in order to potentially make a much larger amount of money.

I am using a combination of asymmetric betting and the Barbell Strategy, which I will explain below, to become wealthy without needing a lot of money.

emergency fundHow I’m Using Asymmetric Bets to Become Wealthy

While earning money, saving money, and investing money is a tried and true strategy for building wealth over time, there’s a catch: it takes a lot of time.

While yes, investing $10,000 a year in the stock market over 30 years will inevitably result in you becoming a millionaire, who wants to work for 30 years and then be wealthy?

$1,000,000 isn’t what it used to be, and really, once 30 years passes, will you have the health and energy to enjoy your wealth?

Personally, while I’m putting some of my money to work in the stock market, I’m also taking an active approach to building wealth.

House Hacking to a Big Asymmetric Payoff

When I was 20 years old, I started learning about how to build wealth. One of my favorite websites and blogs back in 2012 was Financial Samurai.

His article, The Average Net Worth for the Above Average Person¬†had me hooked and thinking, “I’m above average, and wealth is my goal. Where do I need to be when I’m 25, 28, 30, 35? What can I do to build wealth?”

3 years later, I made my first financial splash.

I bought a house the day before my 23rd birthday. 

buying a house at 22When I bought my house, I had a negative net worth. I put less than 3% down, and I wasn’t very handy.

I had less than $2,000 when I moved in.

This was an incredible “risk”. But let’s look at the other side of things.

I had 3 roommates moving in with me who would be paying me rent which would cover roughly 90% of my mortgage. I had a great job – which at the time was paying me $63,000, and if all else failed, I could call up my grandpa and get his opinion on fixing something up.

Thinking in terms of expected value, and the context of this article, what were the possible outcomes and what were the odds of those outcomes?

  • There was probably a chance, maybe 5%, that I would get completely wiped out. 100% loss on my down payment of $10,000, ruining my credit, and no job.
  • There was probably a decent chance as well that some of the appliances would need to be replaced. Maybe this would have cost me $25,000 to update.
  • Another possibly is nothing would go wrong, I would rent out my house for 3 years, and I wouldn’t need to spend too much on repairs and maintenance.

What was the expected value of my investment looking out a few years? Initially, I was forecasting that my net worth would grow about $10,000 from owning this house and house hacking.

Over the last 3 years, I’ve grown my net worth¬†through this house hacking.

I used asymmetric risk to my advantage, and as a result, I don’t have a student loan anymore. I don’t have an auto loan.

Now, I can continue creating a solid financial foundation for my future.

place asymmetric bets to build extreme wealth

Applying the Barbell Strategy of Nassim Taleb to Become Rich

One of my favorite books of all time is The Black Swan, by Nassim Taleb.

In the 90’s, Nassim Taleb was a trader on Wall Street and applied the Barbell Strategy to make money for his firm.

What is the Barbell Strategy for creating wealth?

Essentially, the strategy is to, with 90% of your capital, take little to no risk, and with the other 10% of your capital, invest in a diversified set of very risky asset investments.

This way, your investment portfolio will not be crushed when something goes very wrong; by only risking 10%, the maximum you can lose is 10%.

Let’s do an expected value calculation using the barbell strategy.

Let’s say we put 90% of our capital into something with a 100% chance of returning exactly 0%. With the other 10% of our capital, we have a 50% chance of returning 1000%, and a 50% chance of returning -100%.

What’s our expected value of our return under these conditions?

E(X) = 90%*(100%*0%) + 10%*(50%*1000% + 50%*-100%) = 45%

The expected value calculation yields an expected return of 45%. This is just an example, but something that happens in real life all the time.

personal finance is personal

Why Investing in the Stock Market Might Not Be as Safe as You Think

Over the last few years, I’ve read a number of articles on millionaires.

Since the stock market crash in 2008 and subsequent recovery, there are now many millionaires who mainly have their assets in equities.

Having $1,000,000 in a 401(k) and IRA is great in all, but what happens with a 40% downturn? You just lost $400,000.

I’m invested in the stock market, but am not blind to the fact that large downturns happen every 5-10 years.

Again, while the expected value for returns in the stock market is 7%, the potential drawdown is a little shocking to me.

What if the United States stock market experiences something similar to the Japanese stock market? The Nikkei 225 experienced a 65% drop in 1989 and things still haven’t recovered.

Having a “diversified” portfolio in equities is great in theory, but with medium risk, there is potential for large losses.

What I’d feel better seeing instead is multiple investment classes in your portfolio: real estate, cash, and consider some alternative assets.

My Strategy of Diversifying into Alternative Assets

Over the last year, I’ve been looking into alternative assets to continue to apply the barbell strategy in my financial life.

Everyone wants to find the next Amazon, the next Apple, or the next Bitcoin to throw 100% of their money into and become wildly rich.

That’s stupid to do, and is not what I’m recommending – or what I’m talking about in this post.

Putting a little bit of your wealth into risky assets is the way to go if you want to build wealth offensively, and become rich in your twenties and thirties.

There are three asset classes I’m looking at in particular.¬†These are some things I’m experimenting with. Please assess your own financial situation – I’m not a financial adviser, and would urge you to please do your due diligence before investing in anything.

Here are some assets classes I’ve thrown a little bit of money into:

  • Cryptocurrencies
    • The overall cryptocurrency market is under $1 trillion. The stock market in comparison is around $75 trillion.
    • Personally, I believe the cryptocurrency market could reach $2 trillion, and that would be a 400% return from prices today.
    • I don’t think it will go to 0 as many pundits and people say – institutional money has yet to enter, and now extremely rich people like George Soros are looking to get in, making it seem like it could be a decent bet going forward.
  • Precious Metals
    • Since 2011, silver and gold have been crushed. For example, silver, from a peak of nearly $50,¬†is now sitting around $17.
    • Could silver get back to $50? What about $35?
    • This seems to be a decent asymmetric bet in the next few years, and something I’m experimenting with.
  • My Own Businesses
    • I have a solid day job which is bringing in great income, but to really build wealth, I need to create more and earn more.
    • I’m experimenting with this blog and other side hustles– if these start making a few hundred to a thousand dollars a month, I’ll be creating wealth fast for myself without a lot of money initially invested.

If the barbell strategy is something you think would be valuable to you, the next steps to do your due diligence and look to place some asymmetric bets to become rich.

Finding Expected Values in Personal Finance and Investing

With our knowledge of the concept of expectation, we will now use it to think about asymmetric bets and the expected value of returns of different investment classes.

Hopefully, this will get you thinking about what you can invest in for your financial future.

Before investing, it’s critical to first track your income and expenses, and establish an emergency fund.

After doing these two things, then it’s appropriate to start thinking about getting fancy with your investments.

Remember, the expected value of an event can be thought of as the average outcome. 

The Expected Value of Returns of the Stock Market

On average, the return of the stock market has been roughly 7% a year over the last 100+ years.

Using the language we’ve built up, we could say the expected value of returns for the stock market is 7% a year.

That is not to say there will not be years where there could be a 20% return, or there could be a -20% return.  This is saying that on average, we can expect a return of 7%.

While this 7% does carry some risk, many investors consider the stock market to be a fairly safe investment.

The Expected Value of Returns of Real Estate

Every property and real estate deal is slightly different, and there is also leverage to consider, so there’s no definitive number for the average return for real estate. With that said, for investors, returns on real estate are generally a little more than the stock market.

While the numbers vary, real estate will typically return around 10 to 15% a year.

Thinking about the risks associated with this return, a single house can have a whole bevy or issues: pipes frozen, appliances needing to be replaced, etc. which will eat into the return.

Even though there is risk for there to be reduced returns, with leverage and strong cash flow, real estate can be a great investment.

The Expected Value of Returns for Your Bank Account

This article is not about inflation, how the economy works, and how banks make money, but for all intents and purposes, the return of your bank balance is 0%.

Your money is guaranteed by the government, and while yes, you do get interest paid each month on some types of accounts, relative to inflation, you are losing.

While I believe it’s critical to have an emergency fund, an emergency fund and cash savings is for peace of mind rather than being a source of wealth creation.

The Expected Value of Returns on Debt

The return on debt is precisely the interest rate you are paying on your debt.

Your 5% mortgage has an expected value of a -5% return for your wealth.

Debt has a negative impact on your wealth over time.

The Expected Value of Returns on a Business

This is a tough one. I’m a huge believer that you can use businesses to grow your wealth – and this is something I’m trying to do.

Some people are more successful than others. My current efforts have resulted in a negative hit to my net worth, but I’ve learned a ton.

The possible outcomes here could be $1,000,000, -$15,000, $10,000, or anything in between.

The expected value of your return in business is also dependent on growth, time, and industry.

With this many variables, I’m not sure the expected value here.

The Expected Value of Returns on Cryptocurrencies

Another tough one, and one I’m currently trying to answer.

Let’s look at Litecoin: in 2017, Litecoin returned roughly 5000%.

Could it go to 0? Absolutely. Could it go up another 5000% in 2018, 2019, and 2020? There’s a chance.

What is the expected value for returns for cryptocurrencies? I have no idea, but it could be an interesting bet to try to build wealth for the future.

learn to investBuild Wealth Without Risking a Lot of Money

After getting your emergency fund in place, the next steps with your additional savings should be investing in assets you understand, and building a robust investment portfolio.

Your goals may not include extreme wealth or financial freedom at a young age, but having more money is always better than having less money.

If financial freedom is a goal, it is possible to become rich without needing and risking a lot of money.

The concept of using asymmetric bets is probably a very different thought. I hope this post inspires you to continue to look to expand your perspective on the world, and live with an abundance mindset.

There are so many opportunities out there to make money in the world. We just need to provide targeted value and be compensated for your efforts.

Readers: are you utilizing asymmetric bets to build extreme wealth without needing a lot of money? Are you playing it slow and steady instead? What are your thoughts on alternative assets?

Erik

How to become rich without a lot of money

How to become rich