incentives
Skin In The Game
The rule
If someone's choice can hurt you, they should also feel some of the pain when it goes wrong. No pain for them means no care for you.
Where it flips
Skin in the game can also fool you. A promoter who has put all his money in one stock has huge skin, but every reason to hype it, and he can still be honestly wrong. The fix is to check that the person shares your loss, not just that they have money of their own in it.
The person who takes the risk and the person who feels the loss should be the same. If someone keeps all the profit but hands you the loss, they will gamble in ways they never would with their own money. Before you trust anyone's advice, ask one thing: if this fails, what do they lose? If the honest answer is 'nothing', then their advice is just noise.
A worked example
A bank agent pushes Rohan into a ₹5 lakh product. The agent earns a ₹40,000 fee whether it wins or loses. So his excitement tells Rohan nothing about whether the product is good. [illustrative]
How to spot it
- ·Ask what they lose if the call is wrong
- ·They earn their fee no matter what happens
- ·Advice from someone who never invests beside you
Nassim Nicholas Taleb · Skin in the Game