How to Think in Terms of Risk and Reward Before Making Decisions

We make decisions every day, some small, like whether to hit snooze, starting a business or changing careers. The best decisions come from understanding the relationship between risk and reward. But how do you think about these in a structured way? Let’s break it down.

Step 1: Define the Decision Clearly

When you face a choice, write it down in one sentence. This helps clarify what’s at stake and aligns the decision with your goals. Ask yourself:

• What do I want to achieve?
• Which of my values; health, wealth, or freedom; does this decision impact?

For example:

• Vague: “I want to start a business.”
• Clear: “I want to start a graphic design business to earn an extra $10,000 this year.”

By defining the decision, you set a clear goal that you can measure against potential risks and rewards.

How to Quantify Risks

Let’s say you’re thinking about investing $1,000 in online ads for your business. The worst-case scenario? The ads don’t convert, and you lose the $1,000. To manage the risk, think about ways to mitigate losses:

• Can you start with $100 and scale up if it works?
• Are there free or low-cost ways to test the idea first?

When I started to think in terms of risk and reward, I saved up a capital base as a safety net by saving as much as I could cutting back on pleasures and expensive stuff that would get me further from my goals.

Having capital gives you a chance to take shots when the opportunity shows itself. It’s about preparing yourself and be ready for the moment when it comes.

Step 3: Evaluate the Rewards

What Could Go Right?

Flip the coin and imagine the best-case scenario. Ask:

• What’s the maximum gain? Is it financial, personal growth, or a new skill?
• How much would that reward improve your life?

Returning to the $1,000 ad example: If the ads generate $10,000 in new sales, the risk-reward ratio is 1:10. That’s a smart gamble.

Step 4: Factor in Time and Effort,

Time is a resource too. Before jumping into a decision, evaluate:

• How long will this take?
• What’s the opportunity cost? (What else could you do with that time?)

When I started to pay attention to my health condition, I spent hours searching information with little immediate payoff. But over time, I gathered more information and implemented the new knowledge to my daily life. This helped me regain control of my condition and created results I never expected. The upfront time was worth it because it aligned with my long-term goal: Healing myself naturally and become healthy again.

Step 5: Validate Your Assumptions

Before fully committing, test your idea. This minimizes risks while giving you real-world feedback. Here’s how:

• Pilot projects: Start small and scale up. For example, sell a few products before it’s made and fulfill when you have actual orders.
• Talk to experts: Ask someone who’s done it before about pitfalls and best practices.
• Use data: Research your market or audience before investing heavily. Research and see if there is an interest or need for it. 

Step 6: Align with Your Values

A great decision isn’t just about financial gain, it’s about aligning with what matters to you. Ask yourself:

• Does this support my long-term goals?
  • Health: Will this decision improve my physical or mental well-being?
  • Wealth: Does it create financial stability or opportunity?
  • Freedom: Does it offer more control over my time and choices?

For instance, a high-paying job that demands 80-hour work weeks may boost wealth but harm health and freedom. Always consider the trade-offs.

Step 7: Decide and Act

At some point, you have to act. Avoid analysis paralysis by focusing on these criteria:

• The risk is manageable (loss won’t derail your life).
• The reward is meaningful and achievable.
• You’ve tested or mitigated major uncertainties.

Step 8: Monitor and Adjust

After making a decision, don’t just set it and forget it. Track your progress:

• What’s working?
• What needs adjustment?

When I started my health progress, I noticed certain foods made my condition worse and others made my condition better I also discovered seasonal changes. By paying attention to those outcomes, I improved my ability to control my health condition greatly.

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Examples of Risk and Reward

Here are a few real-life scenarios to illustrate the model:

Health: Starting a Fitness Routine

• Risk: $250 for a gym membership.
• Reward: Better energy, weight loss, and long-term health (priceless).
• Ratio: High reward for low risk. Worth it.

Wealth: Investing in Skills

• Risk: $500 on an online coding course.
• Reward: A job paying $10,000 more annually.
• Ratio: 1:20. A no-brainer if coding interests you.

Freedom: Starting a Side Hustle

• Risk: $200 for materials to make handmade jewelry.
• Reward: $2,000 in profits from Etsy sales.
• Ratio: 1:10. A solid opportunity to gain income and creative freedom.

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The Big Takeaway

Thinking in terms of risk and reward doesn’t mean avoiding risks entirely, it means taking smart risks that align with your goals and values. By following this structured approach, you can make decisions confidently and create a life that supports your health, wealth, and freedom.

So next time you’re faced with a tough choice, pull out this mental model, run the numbers, and go for it. Charlie Munger said,

“All I want to know is where I’m going to die, so I’ll never go there.” In other words, avoid unnecessary risks, but don’t let fear stop you from seizing opportunities.

Never stop improving yourself.