Harry and Linda were living in a small village. They earned their living by catching fish from a river. Both of them worked for 8 hours a day. The difference in their lives depends on what they did during the 8 hours. Harry spent 8 hours catching fish and by the end of the day, he caught 8 fish. On the other hand, Linda spent 6 hours catching fish and the remaining 2 hours to make a net. By the end of the day, she caught 6 fish. As time progressed, she made the net and caught more fish in less amount of time. She caught 8 fish in 4 hours and spent the remaining time making a boat to further enhance her productivity. Linda had a deep understanding of a universal force which led her to boost productivity.
Okay! Okay! I understand your concerns about the universal force hidden in the story but let's first discuss some golden nuggets of the parable.
Cultivate the habit of delaying gratification which means sacrificing the present for a better future. Keep your eyes on the bigger goal. The right approach to a happy life is to embrace long-term thinking.
Linda has leverage over Harry by making a net. She was able to achieve more by doing less amount of work.
Don't become complacent even if you are getting good results. Keep innovating, keep learning, and always hunt for better approaches to do a relevant task. The best results come to those who are obsessed with self-improvement.
Hey smart readers! Did you notice the word leverage? What does it signify?
Leverage is the idea of gaining a substantial amount of output by putting in a small amount of input. The idea of leverage came from physics and was used by the Greeks to move large stones by putting a minuscule muscular force. It is one of the simplest yet innovative inventions.
How does it work? What makes it move heavy objects by putting small force?
A lever is a machine that consists of a bar, fulcrum(Center), moving weight, and the moved weight. By adjusting the center of a fulcrum, a small weight over a large distance is capable of lifting a large weight over a small distance.
Mathematically,
(Heavy Object) / (Distance of small object from the fulcrum ) = (Small Weight) / (Distance of large object from the fulcrum)
The great ideas have enormous reach. They can be applied to solve problems beyond those they are created to solve. The idea of leverage is not confined to lifting heavy weights. It is also applicable to human energy. In Physics, leverage means to lift heavy objects by putting a small amount of force. In human endeavors, leverage means getting maximum productivity by doing a small amount of work. The human brain has evolved to conserve energy. Humans have limited energy and they intend to yield the maximum return per unit of energy spent.
Give me a place to stand, and a lever long enough, and I will move the world. Archimedes
The Pareto Principle is a close cousin of leverage. The idea of the Pareto principle was given by the Italian Polymath Vilfredo Pareto. He was a man of keen observation. In his garden, he observed that 80% of the peas are harvested from 20% of the pea pods. By extending the 80/20 rule to the other areas of his life, he observed that 80% of the wealth was occupied by 20% of the citizens of Italy, 80% of the revenue of any business is generated by the 20% of the clients, 80% of the returns come from the 20% of the stocks, 80% of the clients use 20% of the features of the product, etc.
According to the Pareto principle, 80% of the results are roughly achieved by 20% of the activities. Therefore, focusing on those 20% of the activities gives leverage to reap the maximum benefit. The Pareto principle describes the relationship between input and output which is 20:80. Power law is an acute form of the Pareto principle where the relationship between input and output is 1:99.
Let's understand the Power law with the help of an example.
Do you know that the annual loss caused by the Earthquake is 5.7 billion dollars?
What is the average loss incurred by an Earthquake?
Make a rough guess.
If you are like me you would say it's a couple of million dollars. But surprisingly! the answer is 10,000$. The total number of Earthquakes that occurred in a year excluding the ones that can't be detected by instruments is 5,00,000. The events are not evenly distributed is the core insight of Power law. It is also known as winner takes all advantages.
Why is it known that the winner takes all the advantages?
Let's understand it with the help of real-world examples. Before digitalization, one newspaper was circulated in all the major cities. Initially, the newspaper which has better circulation than others is approached by the advertisers. People are inclined towards those newspapers that have more number of advertisements. It in turn attracted more advertisers because it is popular among people. The entire process creates a positive feedback loop. Therefore, in most businesses, the players who move first will take all the advantages.
A similar pattern is observed in schools, Universities, and Industries. When any student or teacher encounters any problem, they approach the guy who is slightly better than others. He pushes and stretches himself outside of his comfort zone to solve the challenge. He becomes better and more smarter in the process. As word of mouth spreads, more and more people approach him thereby creating a positive feedback loop for his intellectual growth. That is why, 20% of the people enjoy 80% of the opportunities in schools, colleges, and organizations.
The social media apps work on the same principle. Once any social media app crosses a certain threshold, more people will sign up to avail of the services provided by the application. It becomes impossible for people to switch to other products because all their friends and relatives are already on the same platform. Hence, companies create monopolies and it becomes impossible for their competitors to wipe them out of the market.
The rare occurrences that have a significant impact on our lives are known as Black Swan events. This term is given by Nassim Taleb a well-known author popular for his Incerto series. Black Swan events are very significant in the contemporary world.
Pasteur said, like all great discoverers, he knew something about accidental discoveries. The best way to get maximal exposure is to keep researching. Collect opportunities. Nassim Taleb
In hunter-gatherer societies, the things stayed around the mean. When a hunter came across a deer, it was either taller or shorter, thicker or thinner. The world was linear in those times. The modern world is Non-Linear. The handful of actions will increase one's wealth by a factor of 10,000. For example, winning the first prize in the Dream 11 Mycircle app. It is generally said that 40% of the revenue of the directors came from a single film. As the adage goes, 99% of the effort is wasted but we don't know which 1% will create the significant impact on our life. Mark Zuckerberg created other products before Facebook became a hit, J K Rowling had published many novels before Harry Potter became a best-selling book.
How to live a meaningful life?
Ride on the positive black swan events where inputs are highly non-linear to output like writing a book, creating a podcast, or a piece of art, etc. Don't shy away from failures, learn from them. Keep planting seeds so that they become acorns later in life. Avoid negative black swan events like debt, bad marriage, jail, drugs, etc. where the possibility of going wrong will wipe you out from the game.
So far, we have discussed Leverage, Pareto Principle, and Power law. It's time to apply them to improve our lives.
Decision-Making: People mistakenly think that their energy level remains the same throughout the day. The energy is not evenly distributed across the day. 20% of the hours gives 80% of the productivity. A healthy human being takes 8 hours of sleep. As per the Pareto principle, 3 hours(20% of 16) of work produces 80% of the output.
Which three hours among the sixteen hours give the most productivity?
Productivity increases when the glucose level is highest in our body. Glucose will be replenished after getting a good night's sleep. It enables a person to think clearly. Therefore, tackle the most important task in the morning. When the day progresses, the glucose level will keep on dipping as we confront more and more challenges. The energy level is lowest in the evening and we need a full night's rest to replenish the glucose of our body. Don't take any big decisions in the evening.
It is not a shortage of time that should worry us, but the tendency for the majority of time to be spent in low-quality ways. Richard Koch
Elite people like Barrack Obama, Andrew Ng, etc. wear the same dress every day. They don't spend their energy on menial decisions. They spend it on those areas that will create a significant impact in their lives. If you care more about your looks, then assign each dress to each day of the week and save your energy for the important tasks.
Exercise: It is very essential for our mental and physical health. It is a natural medicine to cope with contemporary stress. A healthy man wants many things but a sick man wants only one thing i.e. health. A man wants a fit body, a calm mind, and a heart full of love. Exercise produces chemicals like serotonin in our brain which makes us feel good.
How to do an exercise optimally?
People reap the maximum benefits of exercise when they start feeling discomfort. Spending two hours in your comfort zone won't yield substantial results. The intense 30 minutes in discomfort can yield enormous results. Don't push too much to avoid injuries. Listen to your body and spend an extra minute beyond a threshold. The time spent(20%) beyond the threshold has the potential to bring about(80%) of the results.
Finance: Let's understand the concept of leverage with the help of an example.
Case 1: Suppose you bought an asset worth 10,000$. The 10% increase in the value of an asset brings you a profit of 100$. Similarly, the 10% decrease in the value of an asset makes you lose 100$. But you still have 9,900$ with you.
Case 2: You have 10,000$ in your pocket and you borrow 90,000$ from your friends, relatives, and banks. You bought an asset of 100000 $.
Leverage Ratio = (Asset) / (Equity) = 10
Return = Percentage of Rise/Fall * Leverage Ratio.
Assume the price of an asset is increased by 10%. The 10% rise will give you a return of 100%. You returned 90,000$ to the friends, relatives, and banks. Now you have 20,000$ in your pocket.
Assume the price of an asset is decreased by 10%. The 10% decrease results in a total loss of capital. You are left with 0 $ in your pocket.
Now assume the price of an asset is decreased by 20%. The 20% dip will give you a return of -200%. You lost your money, and owe 10,000$ to your friends, relatives, and banks.
How much fall in value wipes you out of the game?
1/(Leverage Ratio)
If Leverage Ratio is 10 then a 10% fall in the value of an asset results in the permanent loss of capital. For a 20% leverage ratio, a 5 % fall is enough to wipe you out of the game.
If you are leveraged five times your capital, a 20% move in your preferred direction can double your capital, but a similar move in the opposite direction can wipe you out. Naveed Abdali
Leverage in finance means putting a small amount of capital( Small weight) by taking a huge debt( a large distance from the bar) will help you to earn a large amount(Heavy weight) over a short distance(by returning the debt). Without leverage, a 10% increase in the value of an asset helps you to earn a very small amount(100$) in case 1 whereas with leverage, a 10% rise in the value of an asset will help you to earn 10,000$ in case 2. The situation looks scary in case of a fall. However, the crux is to reap the benefits of leverage if and only if the odds are highly in your favor.
Conclusion: The essence of the leverage, Pareto Principle, and Power law is to understand the opportunity costs of our actions. The time spent on pursuing an activity can't be spent simultaneously on other activities. When we say yes to one thing, we simultaneously say no to a hundred other things. Time is our most precious resource. Once it is gone, it is gone forever. Be highly specific to whom you are saying yes. Trade money for time not vice-versa.
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