This article is part of a series on strategies and hacks of self-made billionaire entrepreneurs. We divided it into eight parts: Elon Musk, Charlie Munger, Warren Buffett, Ray Dalio, Jeff Bezos, Elizabeth Holmes, Steve Jobs, and Reid Hoffman.

Billionaire Entrepreneur Strategy

Many thought that Elon Musk was crazy when he plowed all of his PayPal earnings into SpaceX and Tesla. However, there was a proven logic behind Musk's decisions. Musk, like Warren Buffett, uses decision trees to make big decisions.

Decision trees are particularly useful for avoiding stupid risks and big bets that aren't likely to succeed.

Making unlikely big bets.

In an interview with tech entrepreneur Kevin Rose, Musk admits that he thought the most likely outcome for both SpaceX and Tesla was failure. However, they were both so important to the future of humanity and had so much potential that he felt the risk was worth it.

Probabilistically, it makes sense. Here's why.

Financially, if Musk thought that SpaceX could be a $100 billion company and that the chance of success was 30 percent, the expected return statistically using a decision tree is $30 billion. Not bad!

Musk could have easily focused on a company with a $1 billion potential and a 80 percent chance of success. But, in this case, the expected return would only be $800 million.

Avoiding "Russian roulette" risks.

If there is even a tiny chance that doing something could destroy you, it's a very bad idea.

In a talk, Warren Buffett compares these types of situations to Russian roulette: "If you hand me a gun with a million chambers in it, and there's a bullet in one chamber, and you said, 'Put it up to your temple. How much do you want to be paid to pull it once?' I'm not going to pull it. You can name any sum you want, but it doesn't do anything for me."

Smart people fall for this mistake all the time. In the same talk, Buffett shares the story of the collapse of the multibillion-dollar hedge fund Long-Term Capital.

The leadership team included the smartest people in the industry along with Nobel laureates. Yet they played Russian roulette. For every dollar of their money they invested, they borrowed $25. This made them extremely susceptible to a downturn in the market, even a small one. This happened in 1998 and the firm went under in just a few months.

Buffett's point was that all of the company leaders were already extremely wealthy and had spent decades building reputations. So, the incremental benefit of growing richer was small compared with the risk of losing everything, which they ultimately did.

Billionaire Entrepreneur Hack

Utilizing a decision tree does not require a PhD. All that's needed is a basic understanding of probability. Here's a step-by-step process you can follow to use the principles in your decision making:

To get started you don't need to know the exact probabilities. Just following the process will give you unique insights you wouldn't have had otherwise (i.e., the power of unlikely big bets and the risk of Russian roulette decisions).

For a step-by-step guide on how to create decision trees, visit this page. It is an online companion to an economics textbook.

Special thanks to Rachel Zohn, Sheena Lindahl, Emily Shapiro, Austin Epperson, and Ian Chew who volunteered their time to edit this article and do research.

Also thank you to Jessica Newfield, Antonia Donato, Amber Tucker, and Eduardo Litonjua for reviewing the article and providing insightful feedback.


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Published on: Nov 24, 2015