Had Nassim Taleb been born in any other period, he would have certainly been put to death.
~ Carine Chichereau, co-translator of TBS.
Black Swan and Nassim Taleb - Listened to Nassim Taleb on KQED's Forum program, and the ideas about randomness and luck drove me to his recent book, The Black Swan: The Impact of the Highly Improbable.
A read it once, then started over, this time going a bit slower, trying to commune with his counter-intuitive ideas and wonderfully illustrative thought experiments. This books is such a colorful pallet of ideas that somehow connect without falling into a grand theory or trite advice. Indeed, that's part of the Taleb's message in The Black Swan. That theories are contrived and can lead us to a false sense of security or doom. Skeptical empiricism reigns over theory, narrative, and other often misguided simplifications.
What is a Black Swan?
Imagine you randomly select 1,000 people and measure each person's weight and then calculate the average weight for the sample of 1,000 people.
Then take the fattest person that ever lived and add that person to your sample, which now numbers 1,001. Calculate the average again. The new average will be very close, if not essentially identical to the original average. So when measuring weight, one person -- no matter how extreme an example -- does not impact the average weight of the sample.
Now, instead of weight, measure each person's net worth in dollars. Calculate an average net worth for the 1,001 person sample. Then take the wealthiest person in world, and add his or her net worth to the sample and calculate the average. Is the average unaffected by adding one extreme example of net worth to the sample. No. The new average will be MUCH larger than the original. In fact, if you used a sample size of 100,000 people, the sample average would still be hugely affected by that one extremely wealthy person. So when measuring net worth, a single person can have a huge impact on the average of the group. In fact, that one measurement can overwhelm the average and make it meaningless. This is what Taleb means by Black Swan.
Statisticians often refer to these extreme instances as errors, anomalies. In fact, it's common for the average to be calculated by removing the high and/or low values from the calculation, thereby ignoring or trying sweep under the rug a fascinating reality--that reality doesn't always conform to a bell curve. That extremes can overwhelm our expected results (average) and have a gargantuan impact on reality. That's Taleb's message: Black Swans (one extreme, unexpected measurement) can make all the difference.
So a Black Swan is an unexpected event that can overwhelm everything that came before. The financial crisis is an example. Losses from the financial crisis exceed the profits earned over many, many years. To protect ourselves, Taleb suggests that we investors adopt strategies that take advantage of this reality, though he's a little thin on exactly how to do so.
One thing Taleb suggests is to invest most of our money in safe stuff (U.S. Government bonds). That's because a Black Swan can be good or bad--you can't predict. So keep the bulk of your money as safe as you can. But realize that the big growth is found in the "unexpected" and not in "medium risk" investments (e.g., blue chip stock index). Instead, Taleb suggests you take a small percentage of your long-term savings and put it in HIGH risk stuff (derivatives, speculative stocks, etc.). That way you participate in the up side of what you can't predict and won't be killed by the downside. Your biggest gains will be in those black swans; you just don't know when they will happen.
|Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets by Nassim Nicholas Taleb|
|The Black Swan: The Impact of the Highly Improbable by Nassim Nicholas Taleb|
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