Optionality in investments refers to the right to do something, but not necessarily the obligation to do so. The right combination of optionality and underlying portfolio assets more often than not leads to better outcomes than a traditional portfolio. Building optionality into your life, particularly early on, can lead to better life outcomes, too.
Before we move on to the specifics, one of the most important things about optionality is that at some point, you have to exercise the option! This means actually doing what you have the right to do. In the investment world, if you buy a call option a stock, it means that you have the right, but not the obligation, to buy the stock at a predetermined price. At some point, the option may become in-the-money, and you can exercise it and cash in. This is true in life too. Just constantly building optionality will make you better than average, but will also never make you great.
So with that said, let’s talk about the big categories in life, how to build in optionality, and how to exercise it when the time comes. I’m going to do this in the order I feel is most important, and that order may surprise you.
Spouse & Family
I have heard that marriage is the ultimate end of optionality. This is wrong on pretty much every level. When you’re trying to find your partner in life, then yes, pure optionality is the way to go. Figuring out who the right person is can be challenging and frightening, and the consequences of getting it wrong can be pretty severe. So spend some time when you’re young, get into a few serious relationships, and do everything you can to make sure The One is The Right One.
Once you figure out who that person is, then exercise the option! Exercising that option will lead to greater optionality for the rest of your life. I consider myself lucky to have found the right partner and was smart enough to exercise that option. The right partner who is supportive, kind, and most importantly, shares your views about the kind of life you want to build, is vital to building a great life.
Let’s look at ways the right partner helps build optionality in life.
- High paying jobs are generally not offered to recent college grads. Part of building your way up the ladder is putting in the time. Most (if not all) high paying jobs are demanding, both on a time front, intellectually, and even physically. Even the cushiest of desk jobs can be exhausting after a 12-14 hour day. The right partner will help support you during this time, and in particular, understand why you’re doing it. Double this if both partners are on the high-income, high-demand track.
- Maintaining a healthy lifestyle will allow for all of this hard work, and still leave some energy in the tank to have some semblance of an actual life. Finding a partner that shares healthy habits, from eating well to being active, makes it far easier to maintain a healthy lifestyle yourself. In many cases, it’s an absolute necessity.
- Frugality allows for increased financial optionality. As discussed below, a healthy investment account and the correct balance of expenses relative to income increase optionality. Find a spouse that shares this outlook and does not value things that lead to increased carrying costs and ongoing large outflows.
- Family ties can either lead to greater upside or greater downside optionality. Make sure you determine which is important. For example, is the health of the parents poor, and is there a lack of resources that would cause a large burden on you and your spouse? I’m not suggesting that this would be a reason not to marry your partner, but it is something that would reduce optionality later. Perhaps you’d be unable to move for a great opportunity. Or perhaps you’d be unable to start a new business because you need consistent income to help manage family affairs.
- Most importantly, the right partner will support you, including some of your crazy ideas. At some point, you may come across an idea that’s the next Uber or SpaceX, or even just a better local business that leads to a nice mid-sized company. Without a supportive spouse, will you still be able to do this? Will he/she be okay with spending all of your savings, reducing ongoing income so that you’ll have to reduce expenses to the bone, and be comfortable taking the gamble?
Interactions and lifestyle are the best ways to find the right partner. Are they rude to servers, for example? How do they interact with family? Are their parents kind and supportive? Do they eat well and have an active lifestyle? Are they working on side projects or have interesting hobbies, or do they just lounge in front of the TV all night? All of these are different data points that can point you in the right direction. Remember, it’s easy to be average. Don’t fall into that trap.
Without good health, life in every aspect becomes more difficult. This is a tough topic, because there are legitimate injuries that impact the ability to function at a high level. For example, a car crash that leads to chronic back pains or debilitating migraines. If you are in that situation, then doing much of this may be impossible. What I’d like to focus on is lifestyle issues.
High income jobs tend to be demanding jobs. Starting a business, in which you are trying to build something that will pay off down the road, requires near constant working. When I was in my twenties, most workdays were 12 hours, and many times that pushed to 14 hours or higher. Thankfully I was in a field where weekend working was uncommon; not everyone is so lucky. Even today, while my typical day is more like 10 hours, longer days and more frequent travel is the norm. All made more difficult by having young children.
Being healthy maintains the required energy needed to continue this level of physical strain. As I get older, it’s more and more difficult to stay at the appropriate weight and continue to be healthy. I force myself to wake up at 5am every morning to work out. More challenging, I’ve had to begin to really watch what, and how much, I eat. Getting older is not nearly as bad as you make it out in your head when you’re young. But reducing my caloric intake has been worse. I love good food, but I just don’t have the same metabolism that I did when I was younger.
Demands change through the years. Early in your career, it’s ridiculously long hours at the office. Later, it will be up and down all night with young children, and then moving on to school and extracurricular demands. Regardless of what the demands are, good health makes meeting them easier. Without good health, your life optionality will drop greatly. Focus on getting healthy habits established early.
There have been plenty of articles written about building optionality into your career, especially following Nassim Taleb’s books The Black Swan and Antifragile. First and foremost for career optionality is getting an education and building skills. In particular, getting the right kind of education. There are many “follow your passion and the money will come” believers, but believe me when I tell you that your art history or communications degrees are going to be irrelevant. Focus instead on STEM (science, technology, engineering, and math), or on the typical professional degrees (law, medicine, business). These jobs will all allow for maximum optionality early in your career.
Take for example, law or accounting. Now, in all cases, I recommend focusing on firms where you can be part of the revenue generating arm (in these cases, law firms or big accounting firms). But with both of these professions, the opportunities are nearly boundless. Every company needs lawyers and accountants. In the event of a recession, these are also some of the most recession proof jobs. In addition, these are the type of jobs that allow for paying side gigs, whether in consulting, project based work, or building your own small business.
You also want to focus on working either for yourself, or for the “right” kind of firm. Much economics research has (rightly) focused on the employer being a large source of rising inequality. How does this work? If you’ve been an accountant for a middle or large size brick and mortar retailer, odds are high that your pay increases have been minimal in the last 5-10 years. If you’ve worked at Google, on the other hand, it really doesn’t matter what job you’ve had. You’ve probably done all right for yourself. These types of professional degrees tend to point to firms that are service based and spend most of their expenses on employee compensation. A common saying in the investment management business is that the best assets go out the door every night and you hope they come back in the morning. These are the types of business that you should target working for.
With all that said, at some point you’ll have to exercise the option. As you move higher and higher on the pay scale, it naturally becomes more and more difficult to replicate that job elsewhere. At the $250,000 or above level, you now represent less than 3-4% of the working world. So, your 20s are good for building up the option value, and your 30s are when you cash it in. Remember, learn it in your 20s, earn it in your 30s, burn it later. By the time you hit your early 30s, you should have (hopefully) found someplace or started a company that you can expect to call home for a long career, while still maintaining a fair bit of upside.
Even with a solid career with anticipated solid raises, building optionality into your working life still means building something outside of your employment. Even 5-10% raises are no longer the exponential raises that you had experienced in your 20s. That’s where the value of building side businesses comes in. For our family, that has entailed owning a small apartment building and starting this blog. We’re also continually brainstorming small business ideas that have the potential to grow. This has been one of the greatest challenges for us. Neither of us are natural entrepreneurs, but we’re trying!
When all is said and done, building optionality into your finances is strikingly simple. Practice frugality, minimize fixed costs, and build up a nice big pot of accessible capital. However, doing this in real life is more challenging.
This one should be straight forward. Practicing frugality is merely another level of discipline. If you are struggling in this regard, then chances are there are other places where you are lacking discipline in your life. With an above average income (above $250k) in a reasonably priced metro area (not San Francisco or New York City), then you should be maxing out your retirement accounts and still saving a minimum of 25% of your after-tax paycheck. Once you pay off most of your debt (see below), above 50% is better.
There are two sides to the wealth coin: what you save, and more importantly, what you earn. Practicing frugality will not get you exceedingly rich. Practicing frugality will get you an above-average level of wealth and a very comfortable lifestyle. But here’s where practicing frugality builds optionality. It allows you the freedom of potential. With savings and relatively low expenses, you can afford to take a chance. Quit your job and start the business you’ve been dreaming of and planning for. Take a job that has a much higher potential for large income gains, but is much more variable (commission based jobs or any job where an annual bonus equals half or more of total compensation).
Minimize Fixed Costs
From a purely financial standpoint, one of the dumbest things my wife and I did was purchase a vacation home. Not only did we spend a big chunk of capital, we added $1,000-$1,500 per month in fixed costs (property taxes, utilities, maintenance, etc.). From a family standpoint, we made a great decision and I wouldn’t go back on it. In order to have that freedom to start your business or take that variable pay job, you need to minimize fixed costs. Variable costs can be reduced much more easily if needed than fixed costs can. Over time (years, sometimes), fixed costs can also be trimmed, but this is more challenging.
For most high income earners that expect to continue to grow their income, the key is not necessarily reducing or eliminating fixed costs, it’s actually to prevent them from growing (e.g. not buying a vacation home!). As your income grows, these become a smaller and smaller percentage of your income. Presumably, you’re also building a big pile of capital as well.
For us, this also meant paying off our mortgages early. Economically, especially given the last several years in the market, this looks like a bad move. But it is far from dead money. Assume that your mortgage payment is $2,500 (just principal and interest, since you’ll still have taxes and insurance), when you pay off your mortgage, you’ve effectively purchased a bond that yields $30,000 per year. This is not a poor investment, and one of safest around. It gives you the ability to be more aggressive with your remaining savings.
Practicing frugality and minimizing fixed costs both lead directly to building a big pot of accessible capital. And this is what financial optionality is all about. With accessible capital, you’re bullet proof. You can quit your job. You can fund the start-up costs to a new venture. You can take a chance on that new job. Once you have a big pot of available capital, you can exercise any option that you wish.
Building optionality in your life requires you to have the time and energy to go out and get those options. We talked a little about energy in the health section. But having too many time commitments prevents you from building options. For me, having a 10-12 hour work day is one thing. I still have energy and time to play with the kids, eat together as a family, and maybe do something productive. Add a 1-2 hour evening commitment (which would also have to include getting ready and drive time) and that is completely wiped out.
With children, it’s been a challenge for us to keep those minimized and we’re trying to stay vigilant. Our kids are young right now, but as they grow older, those commitments will become greater and greater. We don’t need to be in four sports a year, plus piano lessons, plus language classes, plus, plus, plus. Our goal is to allow our kids to have only one activity per season. In particular, we’re big believers in unstructured time as a way to develop creativity. With kids being so overbooked these days, they have no chance to be kids.
Exercise the Option!
Options are useless unless you’re going to exercise them at some point. Building optionality in your career, for example, is useful early on. However, in order to become a high earner, you need to exercise the option, commit and focus, and build a great career. Or in finances: practicing frugality will only get you so far. But with a big pile of capital and a great idea, go ahead and exercise the option and start that business. Building optionality does not lead to a remarkable life, exercising that optionality does.
Keep building my friends.