TL;DR: Optionality is perhaps the most underrated concept in personal finance and lifestyle design. Having options is valuable because it gives you freedom and flexibility in an increasingly uncertain and changing world. We tend to underrate options because they are difficult to conceptualize. Wherever you can, look for ways to increase your optionality, and it will serve you well!
I loves options. More accurately, I the optionality that can be found in all facets of life. This is because we live in an increasingly uncertain and changing world. Everything from technological innovation to political upheaval makes it difficult to say where we’ll be or what we’ll be doing five years from now. Could you have predicted how you’re living today five years ago? If you’re like me, there’s no way.
That’s why options are so valuable. If you don’t know where your future self will be, how can you make decisions now for that future person? Too often, I find people throwing away their options without considering the consequences or getting adequately compensated for the tradeoff. We do this because Humans are pretty bad at imagining our future self, and we tend to discount the range of outcomes that might be possible, focusing on a more narrow narrative that fits our current view of the world. Understanding the optionality you have in life is a huge source of value that most never even consider. To illustrate, optionality exists everywhere, you just need to look for it.
Coming out of college, it’s unlikely you’ll know what you want to do for the rest of your life. You might not even know what you want to do next week. In this context, it’s great to pursue a path that leaves doors open. I started my career in Management Consulting, which is about as broad as it gets – I was the definition of a generalist. Later in life I narrowed my focus by jumping into an operating role in tech, but not before trying out a number of other career paths and opportunities. As you go through your career, always ask whether a certain experience or opportunity will increase your career options or decrease them. Generalizable skills and abilities (business development, sales skills) often create more options. Industry specific knowledge and relationships are often not very transferable, and therefore limit your options. Neither is necessarily better, but if you’re going to specialize and focus, make sure you’re getting paid for it – I.e. getting a big career / level / seniority bump along the way. As a general rule, it’s better to maintain optionality throughout your 20’s as you’re still growing and figuring out what you enjoy and what you’re good at. As you approach your 30’s, focusing and reducing your options can be a good idea, as going deep can often yield substantial upside if done right.
It’s called dating, and it’s done for a reason. It gives the two (or more?) people involved the benefits of a relationship, without the complicated baggage of lifelong emotional and financial commitment. Try before you buy. I would advise waiting as long as you can before giving up this optionality. People change – especially in their 20’s. The longer you can wait, the more you can learn about yourself before committing to a lifelong journey with someone else. Of course, it might make sense to give up that optionality at some point when you’ve found an amazing person you want to start a family with. The commitment and structure of marriage can bring a lot of benefits in that context, but why give up the option value until you need those benefits? No need to rush in
This is the age old question of rent or buy, and while this depends on a lot of factors, perhaps the biggest one is your life stage and future plans. If you don’t know that you’ll be living in the same city and neighborhood for the next 5-10 years, it’s probably a bad idea to buy. Even though I’m a big fan of ‘house-hacking’, you need to realize you’re taking on a ton of fixed costs and mental commitments that will make it harder for you to consider other options in life. In our dynamic economy, jobs and opportunities can pop up anywhere, anytime, and if you’re locked in to a single city, you’re closing a ton of doors. Much the same as above, don’t give up this optionality unless you’re getting rewarded richly for it – either through much cheaper housing costs (house-hacking), or the long term benefits that come from owning vs. renting
How you invest your money also comes with some inherent optionality. Public market investments, like stocks and bonds, offer a higher degree of liquidity – i.e. you can sell them pretty quickly when needed. This is a form of optionality. Compare this to less-liquid investments like direct ownership of real estate, or investment in private funds or companies. The option to get in or out of an investment is huge, particularly if you think you might need that liquidity in the short term (i.e. pay for a medical bill, down payment on a home). Conversely, if you have excess capital sitting around, you might not need that liquidity as much, at which point it makes sense to consider some alternative investments that are less liquid. Typically less-liquid investments offer higher returns due to a ‘liquidity discount’. For example, typical stock market returns yield 7-10% over the long term. Compare this to investments in real estate funds yielding 15-20%, or private equity funds targeting 20%+ returns. Not all of this difference is driven by a ‘liquidity discount’, but certainly some of it is. For example, when real estate investors take a portfolio of property public in the form of a REIT, they can typically do this for more than they paid for that portfolio – one of the drivers of that difference is the liquidity of the public market REIT structure. In short, people who invest in REITs through public market exchanges are willing to pay more for a set of assets than people who invest directly in those same assets. This difference is real. From my experience the different can be anywhere from 5-10%, which could theoretically double your annualized gains. The question you need to answer is how much do you need the liquidity? If you’re in Ramen Retirement, chances are you don’t need any extra cash at all, so you can afford to invest additional income in less liquid opportunities that provide the chance for greater long term returns
This is the definition of Ramen Retirement. When you have passive income coming in at any time that meets your basic needs, you are no longer dependent on any external actor(s) for your basic financial security. You have the option to allocate your time and energy as best you see fit! This is the sweet spot in life – armed with this form of optionality, you will be able to decide where to invest your most valuable asset – YOU! This type of optionality is so valuable because it will free you up to find the point of leverage where you can have the greatest impact in the world. Too often, we’re so focused on the basic needs, that we can’t take the time or added risks needed to truly explore and realize our full potential. As discussed, the way to get income optionality is to create enough alternative passive streams of income for yourself. One of the best ways to do that is through proper investment of the money you save – so each dollar you save is increasing your income optionality and ability to say no to the things you don’t want, and yes to the things you do!
To close, it should be clear that there are definitely situations where it makes sense to limit your options – choose a wife, commit to a career, buy a home, invest in less liquid assets like real estate or private companies – but if you do, make sure you’re getting compensated appropriately!
Oh, and one last thing – enjoy the journey!