Hedging is used by investors to eliminate or mitigate the risk of a position and to offset losses. It works by taking an opposite position in a related asset.
For example, a farmer might hedge the price risk of grain by negotiating a forward contract, whereby the farmer agrees to deliver a certain amount of grain to a buyer for an agreed price at some point in the future.
Another example of hedging in day-to-day life might be betting against your favorite sports team. This is a form of emotional hedging whereby if your team loses, at least you still win, and vice versa.
You might even hedge your relationship bets by seeing multiple people, or dating one person whilst ‘breadcrumbing’ another.
Breadcrumbing is when you lead someone on romantically through social media or texting. It basically means they’re stringing you along, but with the help of modern technology.
But is hedging always advisable?
To answer that, we must stress that hedging is based on a fundamentally uncertain view of the world.
We hedge because we’re not quite sure our investment in Amazon will pay dividends, or that our team is going to win the Superbowl.
When outcomes are uncertain, it makes sense to experiment and dip our toes in the water, rather than go all-in.
But sometimes, we benefit by being certain about the uncertain.
As is the case on the poker table, providing we have the right hand, we can multiply our returns by going all-in. And as is the case on the poker table, we often won’t know we’ve got the right hand until we’ve shown our cards.
This can be as true in business and the arts as it is in love.
Countless startups had to toil for years before becoming ‘overnight’ successes.
Netflix, for example, was founded in 1997 off the back of an investment from co-founder, Reed Hastings. However, it endured countless setbacks, and it wasn’t until its $50 million sale offer to Blockbuster was turned down that the team did everything they could to find a winning business model. It wasn’t until 2001 that the company started to gain serious traction, going public in 2002 with its IPO. The rest, as they say, is history.
On not hedging, Netflix co-founder Marc Randolph says that “the anxiety of biting a bullet won’t last. But the enjoyment of making that decision will last forever. Go all in.”
Echoing Randolph, Bill Campbell — the late business coach to Steve Jobs, Eric Schmidt and Jeff Bezos, among others — urged his mentees to commit. “You can’t have one foot in and one foot out, because if you aren’t fully committed then the people around you won’t be either. If you’re in, be in.”
Sometimes, it pays to have a ‘reality distortion field’, something the likes of Steve Jobs and Elon Musk have used to galvanize their people to scale to new heights.
In the world of entertainment, it’s difficult to envisage people climbing to the top of the food chain without going all-in. Legendary rock journalist, Mick Wall, says that what many successful musicians had in common is that they had no plan-B. “For them, it was do or die, they had to toil and fail repeatedly and still keep going because they had no choice.”
He eluded to Black Sabbath guitarist, Tony Iommi, who had the tips of his fingers sliced off in a Birmingham factory, and Def Leppard drummer Rick Allen, who lost an entire arm in an automobile accident. Both Iommi and Allen are shining examples of going all-in, despite the obvious deficiencies that would hold most people back.
And when it comes to our romantic relationships, psychologist Barry Schwartz found that, paradoxically, people are happier when they have less choice.
If someone has many options, they may find themselves eternally wondering whether they can do better, never truly committing to the person they are with, and investing their energy into the relationship, and as a result, not getting as much out of the relationship. Schwartz found that people who have less options but truly commit, tend to be happier and more content with their lot than their flush-with-options counterparts.
Risk and reward are proportional to each other.
So as is the case with investing, if the market is performing well then it makes no sense to hedge — it actually costs us money and reduces our returns.
When it comes to relationships, you stand to benefit more from doubling down on the right person than hedging.
But isn’t going all in a risky strategy?
How do we go all-in without sending ourselves to the poorhouse, or spending our lives with someone that makes us miserable?
As former World Series of Poker champion, Annie Duke, puts it, play within your bankroll.
If you have $2,000 in your pocket but have bills and outgoings totaling $1,500 then you don’t have $2,000 to play with, you have $500, and you should not play beyond that.
What are you willing to lose?
When it comes to business, setting a limit to the amount of time or money you want to go all-in with, before pulling the plug, is advisable. This is no different from turning up to an auction with an absolute upper bidding limit that you just won’t go over.
If a romantic relationship is more likely to prosper if you go all-in, you can reduce the risk of going all-in on the wrong person by setting a time-frame, such as three-months into a relationship, to reflect and take corrective action if necessary.
Always cap the downside.
The farmer we introduced earlier might be playing it safe by using a forward contract, but if the price of grain exceeds the price negotiated in the forward contract when the time comes to sell, then the farmer is worse off.
Ultimately, the purpose of a hedge is to protect from losses, so before you hedge your bets, ask yourself if the benefits justify the expense, and always factor the opportunity cost of not going all-in in the expense.
But really, in a world of imperfect information, it often comes down to rolling the dice and hoping that lady luck is on our side. But by being intentional about what we are willing to lose, at least we can walk away from a losing hand and live to fight another day.