Let’s play a game.
Imagine you could have $3,000 right now. Or you could take a 50/50 shot at getting $10,000 or nothing. Which would you choose?
Most people are going to pick the $3,000. That is called the certainty equivalent. These people don’t get rich, but they don’t blow up their financial lives either.
We play this game in real life all the time.
Say you’re a 4th-grade teacher, but you have an idea for a potentially lucrative business. You could stay at your current job, where you might make $35,000–$50,000 a year (more in some states, but that’s the range here in South Carolina). It’s a steady paycheck, and you get medical and retirement benefits. That is your certainty equivalent.
Or you could take a big risk and start that business. Maybe the business fails, and you wipe out your savings. But maybe the business succeeds, and you propel yourself up the economic ladder.
I played this game when I left the military…
Financially, the military is a pretty good deal. You get free medical care. It’s not the best-quality medical care, but it’s free. There’s something to be said for that.
You get unparalleled job security. Don’t do anything extraordinarily dumb, don’t get into trouble, and the military will keep you.
You get free housing. In many cases, you can either live on base or take the housing allowance, which varies from place to place. If you live in Oklahoma, you get a little bit of money. If you live in California, you get a lot. But wherever you are, the housing allowance is not taxable. So, an enlisted guy who’s making $60–$70k per year might get $50k in tax-free income for housing. That is powerful stuff.
You get an allowance for food, although it’s not much. Plan to eat a lot of spaghetti.
You can also bring in extra money through hazard pay. I got it for working on a flight deck. It wasn’t particularly dangerous, but it’s a little scary to have helicopter blades flying right over your head.
I also got a free education from the Coast Guard Academy. Again, powerful stuff.
Then there’s retirement—you can retire from the military after 20 years and continue to receive a large portion of your take-home pay. If you entered the military at 18, you could get full retirement at age 38. If you entered at 22, right after college, you could get it at 42. That is still young. You’d want to bank those retirement checks and move on to a second career.
For twenty-something me, all those military benefits were my certainty equivalent.
But I gave it all up for a job on Wall Street. And it paid off in a big way. So, I took another gamble. By the time I left Lehman Brothers, I was making around $850,000 a year—that was my new certainty equivalent. But again, I gave it all up to start my own business, and again, it paid off.
You have to be a crazy gambler to start a business. Most of all, you have to be willing to bet on yourself.
Just look at Amazon founder Jeff Bezos. In the early ‘90s, he was working at D.E. Shaw & Co., a New York investment bank where he was the youngest senior vice president. His certainty equivalent was being regular Wall Street-millionaire rich—which is still rich! As we all know, Bezos walked away from that life to start an online bookstore. Now he’s the second-richest person in the world.
I’m not saying you should never take the certainty equivalent. Sometimes it makes sense. But life won’t be very fulfilling if that is all you ever do.
Please, do not take giant risks in the stock market with money you cannot afford to lose. If you are going to take risks, do it where you have a fighting chance of having a real edge. When you bet on yourself, you always do.
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