A Strategy for Developing Antifragile Finances
Jacqueline and I have been going through Antifragile: Things That Gain from Disorder by Nassim Nicholas Taleb. The basic idea is that the best systems are not merely robust, but actually thrive during unexpected events, making them “antifragile”—the true opposite to fragility. Applying this to personal finance is particularly interesting to me as it aligns with my thoughts and provides a guide for prudent future action.
Picture a typical American family man: married with a couple young kids, supporting a family primarily off a single income. Let's call him John. John works a normal 9–5 W-2 job. He has a mortgage payment and one or two car payments, and some student loan debt as well. He saves some for retirement in an IRA or 401(k). He has access to life insurance, health insurance, homeowner's insurance, car insurance, and unemployment insurance, all of which help mitigate big risks. This is a good position to be in, and many men lack this kind of financial security. And yet, it's still subject to significant potential downsides. John may survive unexpected “black swan” events, but they would still hurt him.
Is there another option? A way to set yourself up to thrive during unstable times and black swan events? As I discussed before, recent events have made sorting this out a high priority for me. So now picture a second man, in a similar family situation. Let's call him Tom. But instead of having a mortgage and car payments, his family lived on the bare minimum for years and paid cash for a modest house and a car. They're 100% debt-free. And instead of working a W-2 job, he's self-employed, like me. Tom built a small subscription software business over several years and has hired out some of the work such that this business can support his family without taking up all of his time.
Tom uses that extra time to take small risks for other entrepreneurial opportunities. He starts a second software business with one of his friends. He forms a real estate investing company and starts putting as much money as possible into it. He keeps lines of credit (like HELOCs) open and available—not to be used for vacations and new boats, but only for time-sensitive investment opportunities and then paid back quickly. He may not even use an IRA or 401(k), preferring not to lock resources away long-term.
Both John and Tom do well and provide for their families, but Tom is in a better position to both survive black swan events and take advantage of them. Consider the following points:
- Minimized living expenses. Tom sacrificed a lot of comfort to reduce his family's living expenses to the minimum by not carrying any debt. He spent years living as if he were dirt poor even though he wasn't. This means that his family can survive off a much smaller emergency fund, he can accept big delayed rewards like stock instead of pure salary, and there's no risk of a bank foreclosing on his house or repossessing his cars.
- Diversification of income. John may make a lot of money at his typical W-2 job—maybe even more than Tom makes. But because it's all from one source, it could all be lost at once. Tom doesn't put all his eggs in one basket. He has several independent sources of income and a diverse investment portfolio so that no single black swan event could prevent him from feeding his family. This large reduction in risk is worth some reduction in income.
- Passive income. Tom focuses on sources of income that are either passive (like real estate) or can become mostly passive later (like a small business). This has two major benefits. First, injury, family emergency, or vacation is not likely to interrupt the stream of income as much, making it more robust. And second, it can continue to scale. John may get raises as he progresses through his career, but there's generally a ceiling limiting how far his income can grow due to only having a certain amount of time each week. Tom can (at least in theory) scale his income to any amount if he is successful, because he's not limited by the number of hours in a week.
- Ready for opportunities. John is somewhat “locked in” to his job. If a new opportunity comes up, he has to sacrifice his current income, which is a big jump. He can't afford to take risks with it, or explore big opportunities that may not pan out. But Tom leaves himself available for whatever comes his way. He can rebalance where he spends his time without sacrificing all of his income to make way for new opportunities. With his open (but unused) lines of credit, he's always ready to pull cash out in case a great investment comes his way.
- Social capital. This isn't really financial, but I wanted to mention it here anyway. Building up connections in a tight-knit community of close friends provides a better safety net and more opportunity that anything else you can do. I'd rather be poor in a good community than rich without one.
The differences between the strategies followed by these two men should be clear. John focuses on preventing disaster from certain unlikely events with insurance. Tom does that too, but to a much greater degree—he's relatively well-protected against true black swan events, for which there is no insurance. And, most importantly, he puts himself in a position where he can gain from such an event by being able to adapt quickly. Consider a board game analogy: there are some people who pick a good strategy and follow it through to the end. It's reasonable, safe, and effective. Then there are people who can rewrite their strategy on the fly, adapting to whatever happens in each round. These people can perform well in any situation, no matter what the other players do.
There's a major theme here that's worth pointing out: delayed rewards. In many areas of life you can choose to make sacrifices now for a large future benefit. For example, exercising every day in order to get in shape and live longer. Or not eating out so that you can pay off your debts quickly. Or moonlighting for your startup business instead of playing video games. Or having a large family and dealing with little people's poop every day in order to raise the next generation and have many grandchildren. People who are willing to accept these long-term deals are more successful than those who just want comfort and pleasure right now.
To be clear, working a W-2 job and providing for your family is not bad in any way; if you're fulfilling your duties then you're winning. It's just not ideal from a risk management perspective. The main point is to stop living in the moment and think about the future carefully. Take small steps in your life that get you closer to being antifragile. What can you do this year to make sure that no matter what happens your family will still be okay?