Taleb's Turkey & the Strategy of Uncertainty

Imagine you are a turkey.

Enjoying free range life on a pastoral farm.

You’re fed a highly caloric diet every day, treated well, and there are no coyotes, bobcats, or foxes chasing after you like in the wild.

Life is good.

And then, all of a sudden…

The fourth Thursday of November is right around the corner… and suddenly your life is cut short in one fell swoop. 🪓

That’s a pretty rude awakening!

You had absolutely no reason to believe it would be the day you’d meet your maker. There were no prior indicators.

Furthermore, there’s absolutely no way you could have pieced together any clues and figured out that this day was coming.

You simply didn't know what you didn't know.

Ah, Thanksgiving! 🦃

Nassim Nicholas Taleb uses this story to illustrate the concept of a “Black Swan” event, which has three defining characteristics:

  1. It’s entirely unpredictable.

  2. It results in severe and widespread consequences.

  3. After its occurrence, people will rationalize the event as having been predictable.

The 2008 financial crisis, 9/11 attacks, and the current pandemic are all commonly considered Black Swan events.

Beyond the obvious, Taleb also uses the example of attending a statistical conference in Vegas, and discovering the most catastrophic losses ever incurred by the casino hosting the event came not from big wins on the slot machines, patrons cheating the house, or servicing the multi-billion dollar debt it takes to open such a property.

Instead…

  • A tiger mauled a performer during a stage act, which wasn’t covered by their insurance.

  • A key employee was negligent in filing paperwork with the IRS for a number of years.

  • Finally, the owner’s daughter was kidnapped and held for ransom, and in a panic, he dipped into the casino’s funds to get her returned safely.

Now take a moment to think about the above.

Casinos are literally in the business of ensuring statistical probability is in their favor… Yet all of the above were completely ​​unprecedented; no one could have possibly anticipated them.

These are classic Black Swans.

And note that while they’re most often thought of as negative occurrences, they can also be positive in effect.

Take the rise of user-generated content on social media, the market dominance of peer-to-peer exchange services like Uber and AirBnb, and the birth of a new asset class in cryptocurrencies.

No one could have anticipated the cultural-shifting success of these technologies either.

So here’s the million dollar question…

How do we reap the benefits of positive Black Swans, while minimizing the adverse impact of negative Black Swans in our portfolio?

The answer lies in another Talebism: the “barbell” investment strategy. 🏋️

It works like this…

You split your investments into starkly contrasting high-risk assets and low-risk assets, forgoing medium-risk assets in-between.

The logic is this: you can dramatically minimize the negative impact of volatility on your portfolio with your low-risk assets, while still tremendously benefiting from upside volatility with your high-risk assets.

This extremely polarized approach conceptually “looks” like a barbell, though not a particularly balanced one.

Taleb recommends keeping ~90% of your assets in low-risk asset classes.

Personally, he recommends T-Bills (aka Treasury Bills, a short-term debt instrument that gives your cash a higher yield than your bank is paying you, without much hassle).

For our purposes, gold would also work well here.

Then, with the ~10% remaining capital, Taleb recommends allocating it across a wide range of high-risk bets across many industries and geographies.

These could be penny stocks, exploratory mining operations, crypto speculations, etc.

The advantage of this framework lies in minimizing loss with the vast majority of your assets and offsetting the slow growth with the potential gains from the high-risk portion of your portfolio.

This is akin to the “Vegas money” approach to speculation: You only invest what you can lose and you aggressively seek out such opportunities.

Imagine if you’d invested in Bitcoin the first time you heard about it? A $1000 investment in 2014 would now be worth $37,000.

Or, what about something more mainstream, like Amazon? A $1000 investment in 2000 would now be worth $50,000.

Not bad for such relatively small bets, right?

That’s the idea of the barbell strategy…

Even if you’re only investing assets you can afford to lose, you can still make outsized gains.

This is a prudent approach to crypto, as an example. It’s a smart move to make “barbell” bets in this hyper-volatile asset class, so you can position yourself to reap the rewards during future bull runs.

Sic semper debitoribus,
~ West & Zack

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SHOWER THOUGHT

"The three most harmful addictions are heroin, carbohydrates, and a monthly salary."

― Nassim Nicholas Taleb

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ADDENDUM

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