The books Anti-fragile, The Black Swan and Fooled by Randomness
Nassim Nicholas Taleb is an interesting human. I have read his books and quite a few of his other written works. None make much sense at first glance, but there is an underlying thread you can derive.
The principles are straightforward enough, but his expression of them is less so. That’s okay. Anything worth knowing is worth working to learn.
Fooled By Randomness
You cannot categorically decide that skill is involved in earning more with a portfolio than the market itself makes. As Taleb point out, if the probability of doing better in a year is 50%, the probability of doing better 10 years in a row is about 1 in 1,000 If there are 10,000 fund managers, we could reasonably assume there are 10 of them that have a 10 year track record that is the one we all seek.
Knowing they have done this does not say anything about how they have done it or whether or not the method is useful, transferable or repeatable. It could merely be random chance.
That won’t keep them from writing a book, nor will the result fail to appear in the funds marketing material.
The Black Swan
This book leads us to notice the rare event. The idea that unless something is strictly prohibited from happening, it will happen. Some Swans are bad, some not. The key takeaway is be sure you have not made positive Black Swans impossible in your structure.
No major country could default on their bonds, was an implicit assumption in Long Term Capital Management. LTCM ceased to exist not long after they did. Beware implicit assumptions.
Many portfolios and trading tactics are based on a long chain of events. They may be historically accurate, but smart investors do not rely on accuracy and completeness being present. There are possible things that have not happened yet. You cannot discount them to zero.
Humility is a great asset. Always believe there is something else to know and the something may be crucial.
Taleb was a fund manager. His perception was different than his peers.
Suppose his fellow managers had to estimate the future and adjust their portfolio accordingly. All of his fellows thought there was a 90% chance the market would be up next month. They were almost fully invested.
Taleb on the other hand was nearly all cash. When asked he said, “I think there is a 90% chance the market will be up 1% next month and a 10% chance it will be down 20%.”
Never assess decisions in the isolation of a single variable, no matter how important the variable seems.
The book is truly insightful, albeit a difficult read.
Taleb isolates three conditions. Fragile, robust and antifragile.
Fragile is a condition where any adverse event breaks the model or portfolio or plan. Portfolio concentration is fragile.
Robust tolerates adverse events and the structure is not harmed. Usually there is a cost to be robust instead of fragile, but it seems worth the price. Diversity is a way to build robust portfolios.
Outside investing, robust has some flaws. Principally they do not accommodate change very well. Some changes should change the structure. It is a hard path to tread between robust and suitably flexible.
Antifragile is a novel thought and very insightful. It essentially says, there are some structures that benefit from chaos. Portfolios can be constructed to accommodate rare events. The implementation of positive black swan events.
To some extent it is a numbers game with one rule.
Whatever you do, the outcome must be either win huge or lose tiny. Options become a key part of the plan.
It is not entirely human
The problem for we humans is that many small losses eventually get on our nerves. Losing $1,000 50 times and making $200,000 once is arithmetically desirable but humans don’t work that way. A loss is a loss. You will need a distraction to play this game.
What to do
A problem once recognized is solvable. You may prefer robust to fragile. The many baskets or the one basket for your eggs. For many people options, and the many other derivatives are too complex to think about or be comfortable with. Options are after all, a super-form of leverage.
The wisdom is know yourself, your objectives and your resources before embarking on any investment adventure.
Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario.
In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.
Please be in touch if I can help you. email@example.com 866-285-7772