Nate Silver On The Edge: Processable Insights for Entrepreneurs

I read Nate Silver’s on the edge on a recent trip to the California desert. The book is not really entrepreneurship or owned by small companies per se. The book talks about people who take risks and are rewarded.

But Silver’s book? The tactics and risk management tricks that describe players, casinos, risk capitalists and artificial intelligence developers? That is also quite applicable to small businesses. Therefore, I would recommend putting On the edge On your reading list. And in case you take you while you get to the book, let me highlight a handful of interesting risk management ideas.

Idea #1: Most people take very few risks

A first idea backed by a lot of research: most people risk very little. Poker players, investment merchants, entrepreneurs, etc.

And why does this matter: unfortunately, avoid or dodge risks? A habit or destructive and non -profitable practice.

The processable vision here: most of us (including me) take very few risks.

Idea #2: Testosterone levels affect and are affected by risk

A second idea that invites the reflection of the book: testosterone levels are linked to risk taking.

For example, people (yes, mostly men) with higher testosterone levels tend to assume more risks. And why most of us are risky very little? That superior testosterone effect could be a good thing.

But something else to keep in mind: according to Silver’s investigation he reviews and discusses, the successful impulses of risk taking. So, some people may experience a compound here. The highest levels of testosterone extend the risk taking. (Initially good). That risk taking results in rewards. (Again, well.) Those rewards increase testosterone. (So ​​far, so good). That triggers more amazement of risks. (Okay, maybe good … but at some point it is not good).

In any case, something to consider. Especially if you have experienced a massive impulse in your testosterone levels because you are leaving a giant success.

Idea #3: Cortisol levels affect risk tolerance

A related hormonal problem: anxiety levels and cortisol stress hormone levels affect people’s risk tolerance.

So, this processable vision: tensions and anxieties of things out of work? That can obviously reduce our ability or will to take risks. That makes sense.

But if the risks and the rewards for gathering or carrying the risk is one of the things that entrepreneurs do? Perhaps the owners and businessmen of small businesses need to think more about anxiety things.

Idea #4: Put often problematic

An idea that jumps to another area.

When talking with players who take risks and also with risk capitalists, Silver talks about the challenge of finding opportunities to assume the risk intelligently.

A handful of times in the book, talks about the challenge facing good poker players trying to find good games or tournaments to play. Or about the best sports that struggle to find online gaming stores willing to bet.

I see a connection here for you and your small business. (I suppose your small company is or will be successful). And the connection is this: yes, you should obtain excellent yields of your investment of small businesses. Much better than will win if “withdraws its chips” and then invests in public cautial markets. Therefore, you (and I) want to think very carefully about taking money from the table, so to speak.

You and I can want our winner to continue winning.

Example: Let’s say your small company generates $ 200,000 a year in profits and that the company could sell for $ 500,000. (That would reflect a common assessment). Seen from a perspective, it is obtaining a return of 40% of its investment. If you charge the $ 500,000 and invest in the stock market? Well, at this time, with the current valuations of US shares, US investors could earn $ 10,000 to $ 20,000 annually. Therefore, you may want to keep your money invested in your small business.

Idea #5: Kelly criterion suggests when to sell?

A final risk vision: a formula of the game world and then (strangely) finance, Kelly’s criteria suggest how much you or I should have invested in a small high -risk business.

Assuming that the entrepreneur is totally risky tolerant, more about this in a minute, Kelly’s criteria for the assignment of fractional wealth to a risky asset as a small company is:

(Expected-Riskless return without risks)/(Volatilty²)

This formula seems complicated. But mathematics work more easily than I could expect.

Example: Let’s say that the return you expect from your small business is equal to 25%. Let’s say that the performance without risks you can obtain from the United States Treasury bonds is equal to 5%. Finally, let’s say that volatility, or standard deviation of your small business, is equal to 50%. (All these numbers are quite precise conjectures in many cases, by the way).

With these entrances, Kelly criterion formula is seen as:

(25%-5%)/(50%²)

That 25% -5% numerator equals 20% obviously. Therefore, the capital risk premium is equivalent to 20%

That 50%² The denominator is equivalent to 25%.

And 20%/25%is equal to 80%.

Therefore, the owner of the small risk tolerant business could rationally choose that 80% of it or its wealth invested in a small company that generates a 25% yield with 50% volatility if assets without risks return 5%.

Note: We have a previous blog post on Merton’s actions that work identically to Kelly’s criteria in this situation. This blog post provides an additional calculator and background information about how formula inputs occur.