Nassim Nicholas Taleb
Recalibrating Your Understanding of Risk
What do you think is the opposite of fragility? When Taleb poses this question, the most common response is robustness. Yet, the opposite of negative would not be neutral, so why would robustness be the opposite of fragility? Fragile systems collapse under pressure. The 2008 financial market was a fragile system that was brought down under the weight of its own risk. Systems that are robust can withstand the shock of an adverse event. During an earthquake, if the building can withstand the blast, it’s robust.
What happens when you lift weights? The process of lifting weights is an adverse shock to your body. Lifting literally tears apart your muscle tissue, only to build it back stronger than it was before. Taleb coined the term antifragility to describe systems that thrive in the event of stressors. If you look, antifragile systems are all around us. Our bodies are one of the most antifragile systems on Earth. When we contract a virus, like Covid-19, the stressor leaves our body better off than it was before, building up antibodies and strengthening our immune system against future attacks. The entire beauty of evolution is that organisms thrive under black swan shocks.
“Some things benefit from shocks; they thrive and grow when exposed to volatility, randomness, disorder, and stressors and love adventure, risk and uncertainty. Yet, in spite of the ubiquity of the phenomenon, there is no word for the exact opposite of fragile. Let us call it anti-fragile. Anti-fragility is beyond resilience or robustness. The resilient resists shocks and stays the same; the anti-fragile gets better.”
Nassim Taleb: Antifragility
Applying Antifragility to Investing
So how does this relate to our investing philosophies? Crazy shit in the market happens all the time. Black Swans can be both positive and negative. Stay in the market long enough, and depressions are not a possibly, but a reality. Wouldn’t it be nice for your portfolio to thrive when the world around you is plummeting? Conversely, don’t you want to be a part of the next breakthrough innovation? We want as much exposure to the fat tails as we can get. Financial pundits preach discipline and caution to minimize risk, so that we can withstand shocks to the financial markets (robustness). Instead of being robust, we should construct our portfolios to be antifragile.
To construct a portfolio that benefits from shocks to the market, we need to be long volatility (vega). In other words, we need to be betting on the idea that at some point, something will cause the markets to either free fall, or rocket upwards. We want to bet on uncertainty. Keep in mind, we aren’t betting on low volatility stressors, like small earnings beats, or mild economic uncertainty. We are betting on total shit-storms that wreck economies and put countries into economic depressions.
The best way to do this is to invest in deep out of the money options. We can do this with put options for the negative black swans, and call options for the positive events. I allocate a small portion of my portfolio to these financial instruments. Investors vary on their opinion of how “deep” you should go, but I aim for put options that will expire in the money starting around a 35% market decline. When we purchase these put options, we are going to be wrong frequently. By frequently, I mean that almost every single put we buy is going to expire worthless. That’s because Defcon 1 doesn’t come around every couple of years, or even every decade. But that’s the entire point: we aren’t collecting nickels in front of a steamroller, we are the steamroller now.
If you think about it, volatility, risk, and time are really the same thing. With time, instances of extreme volatility aren’t a possibility, they are a certainty. Wouldn’t you like to be on the sure side of a bet?
Taleb’s Best Quotes
“I don’t read the papers; I stopped reading the papers. I read the papers only during periods of crisis, and I think papers are too long on a regular day and too short days when we have a crisis.”
It’s important to separate the white noise from the signal. Most days, what you’re reading is fluff and not substance. This is why I don’t read the news – I like to hear about current events from other people. If people aren’t talking about it, it’s probably not that important.
“The psychologist Gerd Gigerenzer has a simple heuristic. Never ask the doctor what you should do. Ask him what he would do if he were in your place. You would be surprised at the difference.”
Don’t ask people for their financial recommendations. Ask them what they hold in their portfolio instead. Only a person who has skin in the game can be judged as credible.
“Antifragility is beyond resilience or robustness. The resilient resists shocks and stays the same; the antifragile gets better.”
Do you want to be the one collecting nickels in front of a steamroller?
“If you hear a “prominent” economist using the word ‘equilibrium,’ or ‘normal distribution,’ do not argue with him; just ignore him, or try to put a rat down his shirt.”
Outside of closed systems, normal distributions are hard to find in the stock market.
“The problem of knowledge is that there are many more books on birds written by ornithologists than books on birds written by birds and books on ornithologists written by birds”
The Bed of Procrustes: Philosophical and Practical Aphorisms
