Naval: An externality is where there’s an additional cost imposed by whatever product is being produced or consumed, that’s not accounted for in the price of the product. This can happen for many reasons. Sometimes you can fix it by putting the cost back into the price.
Naval: Net present value is when you say, “That stream of payments I’m going to get in the future—what’s it worth today?”
Here’s a common example: You’re joining a startup and getting stock options, and the founder says, “This company is going to be worth $1 billion, and I’m giving you 0.1% of the company; therefore, you’re getting $1 million worth of stock.”
Naval: Relationships offer a good example of compound interest. Once you’ve been in a good relationship with somebody for a while—whether it’s business or romantic—life gets a lot easier because you know that person’s got your back. You don’t have to keep questioning.
If I’m doing a deal with someone I’ve worked with for 20 years and there is mutual trust, we don’t have to read the legal contracts. Maybe we don’t even need to create legal contracts; maybe we can do it with a handshake. That kind of trust makes it very easy to do business.
Naval: Pareto optimal is another concept from game theory, along with Pareto superior.
Pareto superior means something is better in some ways while being equal or better in other ways. It’s not worse in any way. This is an important concept when you’re negotiating. If you can make a solution Pareto superior to where it was before, you will always do that.
It’s about multiplayer games where people respond based on what they think the other person’s response will be. He came up with a mathematical formalization to answer: How do you get people who cannot communicate with each other to coordinate?
Naval: The Kelly criterion is a popularized mathematical formulation of a simple concept. The simple concept is: Don’t risk everything. Stay out of jail. Don’t bet everything on one big gamble. Be careful how much you bet each time, so you don’t lose the whole kitty.
If you’re a gambler, the Kelly criterion mathematically formulates how much you should wager per hand, even if you have an edge—because even when you have an edge, you can still lose. Let’s say you have 51-to-49 edge. Every gambler knows not to bet the whole kitty on that 51-to-49 edge—because you could lose everything and won’t get to come back to the average.
Naval: So mental models are all the rage. Everyone’s trying to become smarter by adopting mental models. I think mental models are interesting, but I don’t think explicitly in terms of mental-model checklists. I know Charlie Munger does, but that’s just not how I think.
Envy can give you a powerful boost, or it can eat you alive if you let it follow you.
Nivi: Do you want to tell us about jobs you had growing up and the one that kicked off your fanatical obsession with creating wealth?
Naval: This gets a little personal, and I don’t want to humble-brag. There was a thread going around Twitter—Name Five Jobs You’ve Held—and every rich person on there was signaling how they’ve held normal jobs. I don’t want to play that game.
I’ve had menial jobs. There are people who had it worse than me and people who had it better than me.