Monday, September 16, 2013

Spreading Your Bets

Nico asked us to think about the following hypothetical: five poor people need help. Each needs $5 to get cloth and have a chance of getting a job. You only have $5. Do you give it all to one person or do you give $1 to each? After a bit of debate we concluded the following: If giving $1 to each increase the likelihood that some could get the remaining $4, in other words, you contributed more than just 20% to their likelihood of success, then that was a better way to go. If you only contribute 20% to their chances of success, then both options were equivalent, and if your dollar increase their odds of success less than 20%, then better to give $5 to one person. How could giving them 20% of their needs increase their odds more than 20%? Maybe the first dollars motivates them to be more proactive about looking for the remaining $4. Or maybe the fact they already have $1 will make it more likely that others help them.

I spoke a bit about investing: $1 investments in five companies vs. a $5 investment in one company. The first approach is more diversified. You are less likely to loose all your money. You are also less likely to hit a home-run. And there are other factors to consider: if successful investments improve your reputation (like they do for venture capitalists and angel investors) then the diversified approach has an advantage: you have a higher likelihood of having a successful outcome that you can "advertise", while people wont find out about your bad investments. Furthermore, people won't know whether you invested $1 or $5 in your successes. Of course, if your priority is to increase the likelihood of a home-run you are better of making bigger bets on fewer companies...

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