Нассим Талеб - The Black Swan. The Impact of the Highly Improbable

Philosophers since Aristotle have taught us that we are deep-thinking animals, and that we can learn by reasoning. It took a while to discover that we do effectively think, but that we more readily narrate backward in order to give ourselves the illusion of understanding, and give a cover to our past actions. The minute we forgot about this point, the “Enlightenment” came to drill it into our heads for a second time.

I’d rather degrade us humans to a level certainly above other known animals but not quite on a par with the ideal Olympian man who can absorb philosophical statements and act accordingly. Indeed, if philosophy were that effective, the self-help section of the local bookstore would be of some use in consoling souls experiencing pain—but it isn’t. We forget to philosophize when under strain.

I’ll end this section on prediction with the following two lessons, one very brief (for the small matters), one rather lengthy (for the large, important decisions).

Being a Fool in the Right Places

The lesson for the small is: be human! Accept that being human involves some amount of epistemic arrogance in running your affairs. Do not be ashamed of that. Do not try to always withhold judgment—opinions are the stuff of life. Do not try to avoid predicting—yes, after this diatribe about prediction I am not urging you to stop being a fool. Just be a fool in the right places. *

What you should avoid is unnecessary dependence on large-scale harmful predictions—those and only those. Avoid the big subjects that may hurt your future: be fooled in small matters, not in the large. Do not listen to economic forecasters or to predictors in social science (they are mere entertainers), but do make your own forecast for the picnic. By all means, demand certainty for the next picnic; but avoid government social-security forecasts for the year 2040.

Know how to rank beliefs not according to their plausibility but by the harm they may cause.

Be Prepared

The reader might feel queasy reading about these general failures to see the future and wonder what to do. But if you shed the idea of full predictability, there are plenty of things to do provided you remain conscious of their limits. Knowing that you cannot predict does not mean that you cannot benefit from unpredictability.

The bottom line: be prepared! Narrow-minded prediction has an analgesic or therapeutic effect. Be aware of the numbing effect of magic numbers. Be prepared for all relevant eventualities.

THE IDEA OF POSITIVE ACCIDENT

Recall the empirics, those members of the Greek school of empirical medicine. They considered that you should be open-minded in your medical diagnoses to let luck play a role. By luck, a patient might be cured, say, by eating some food that accidentally turns out to be the cure for his disease, so that the treatment can then be used on subsequent patients. The positive accident (like hypertension medicine producing side benefits that led to Viagra) was the empirics’ central method of medical discovery.

This same point can be generalized to life: maximize the serendipity around you.

Sextus Empiricus retold the story of Apelles the Painter, who, while doing a portrait of a horse, was attempting to depict the foam from the horse’s mouth. After trying very hard and making a mess, he gave up and, in irritation, took the sponge he used for cleaning his brush and threw it at the picture. Where the sponge hit, it left a perfect representation of the foam.

Trial and error means trying a lot. In The Blind Watchmaker , Richard Dawkins brilliantly illustrates this notion of the world without grand design, moving by small incremental random changes. Note a slight disagreement on my part that does not change the story by much: the world, rather, moves by large incremental random changes.

Indeed, we have psychological and intellectual difficulties with trial and error, and with accepting that series of small failures are necessary in life. My colleague Mark Spitznagel understood that we humans have a mental hang-up about failures: “You need to love to lose” was his motto. In fact, the reason I felt immediately at home in America is precisely because American culture encourages the process of failure, unlike the cultures of Europe and Asia where failure is met with stigma and embarrassment. America’s specialty is to take these small risks for the rest of the world, which explains this country’s disproportionate share in innovations. Once established, an idea or a product is later “perfected” over there.

Volatility and Risk of Black Swan

People are often ashamed of losses, so they engage in strategies that produce very little volatility but contain the risk of a large loss—like collecting nickels in front of steamrollers. In Japanese culture, which is ill-adapted to randomness and badly equipped to understand that bad performance can come from bad luck, losses can severely tarnish someone’s reputation. People hate volatility, thus engage in strategies exposed to blowups, leading to occasional suicides after a big loss.

Furthermore, this trade-off between volatility and risk can show up in careers that give the appearance of being stable, like jobs at IBM until the 1990s. When laid off, the employee faces a total void: he is no longer fit for anything else. The same holds for those in protected industries. On the other hand, consultants can have volatile earnings as their clients’ earnings go up and down, but face a lower risk of starvation, since their skills match demand— fluctuat nec mergitur (fluctuates but doesn’t sink). Likewise, dictatorships that do not appear volatile, like, say, Syria or Saudi Arabia, face a larger risk of chaos than, say, Italy, as the latter has been in a state of continual political turmoil since the second war. I learned about this problem from the finance industry, in which we see “conservative” bankers sitting on a pile of dynamite but fooling themselves because their operations seem dull and lacking in volatility.

Barbell Strategy

I am trying here to generalize to real life the notion of the “barbell” strategy I used as a trader, which is as follows. If you know that you are vulnerable to prediction errors, and if you accept that most “risk measures” are flawed, because of the Black Swan, then your strategy is to be as hyperconservative and hyperaggressive as you can be instead of being mildly aggressive or conservative. Instead of putting your money in “medium risk” investments (how do you know it is medium risk? by listening to tenure-seeking “experts”?), you need to put a portion, say 85 to 90 percent, in extremely safe instruments, like Treasury bills—as safe a class of instruments as you can manage to find on this planet. The remaining 10 to 15 percent you put in extremely speculative bets, as leveraged as possible (like options), preferably venture capital–style portfolios. *That way you do not depend on errors of risk management; no Black Swan can hurt you at all, beyond your “floor,” the nest egg that you have in maximally safe investments. Or, equivalently, you can have a speculative portfolio and insure it (if possible) against losses of more than, say, 15 percent. You are “clipping” your incomputable risk, the one that is harmful to you. Instead of having medium risk, you have high risk on one side and no risk on the other. The average will be medium risk but constitutes a positive exposure to the Black Swan. More technically, this can be called a “convex” combination. Let us see how this can be implemented in all aspects of life.

“Nobody Knows Anything”