November 5, 2021

Principle of Affordable Loss


Focus on the downside risk.  Crucial to note that downside risk in this context has nothing to do with the opportunity, the idea, the business model, or anything external.  Rather, downside risk is singularly about how much can I--the personal "I" afford to lose.

Even if effectual reasoning fails to improve the odds of entrepreneurial success, it reduces the cost of failure in terms of absolute dollars (bounded by a subjective and idiosyncratic derivation of "affordable loss") and cost of time by cutting losses short.


Conventional / causal approaches to entrepreneurship tend to look at the upside of the opportunity, which is inherently unpredictable in uncertain domains.  Against this traditional model, pre-defining one's risk of loss is critical to (a) work within realistic constraints (and then push them incrementally if traction emerges) and (b) avoid confirmation bias and path dependency, as well as (c) leaving relationships sour.

Pre-defining losses at different stages--but especially and crucially, at the start--also avoids the ruse of "all or nothing" thinking that entirely short-circuits entrepreneurialism.

Affordable loss is decidedly a financial calculation (and an inherently personal, idiosyncratic one) but also includes questions of time / energy.  So, at the start, the best derivation of affordable loss is for each collaborator to determine his/her personal budget parameter as well as time parameter.

There's a direct link between the Affordable Loss Principle and a systematic trading strategy.  In the latter, key risk management tools can include (a) stop loss and/or (b) time-based stop loss.