What I've learned from Nassim Taleb

I've enjoyed Nassim Taleb’s work for a while now. I love his books “Fooled by Randomness” & “Antifragile” and have read them multiple times. I’ve also spent time going through “Black Swan” & “Skin in the Game”.

Let me clarify though, this isn't an attempt to write a note that covers all his books. Of course not. That's impossible and not my intention. This is more for me. I’m simply touching on some ideas that his books have inspired me to look into.

All risks are not the same

Remember when Covid had just happened, and we were seeing articles about how more people die in car accidents than they do from this virus?

Even President Trump said “You look at automobile accidents, which are far greater than any numbers we're talking about. That doesn't mean we're going to tell everybody no more driving of cars. So we have to do things to get our country open.”

A stupid comparison to say the least. Your neighbour having a car accident does not impact your chances of having one. Whereas your neighbour getting a virus has changed the odds of you getting it too.

When thinking about risks, it's crucial to think about the scalability of that risk.

Car accidents typically fall within the realm of what Taleb calls "Mediocristan". Mediocristan is a world characterized by stability and predictability, where outliers don’t dramatically impact the mean. This world follows a normal distribution. For instance, consider human height. If you randomly select 100 people and then add the tallest man in the world to that group, the average height won't change much.

The flip side of Mediocristan is a world Taleb calls “Extremistan”. In Extremistan, outliers completely change the mean. Think about average wealth for a second. If you take those same 100 people and add Bill Gates to the mix, the average wealth of that group will skyrocket. The outlier completely changes the mean.

When we are dealing with risks that are scalable in a manner that they belong to Extremistan, we have to exercise caution and, most importantly, not compare them with something in Mediocristan.

Sequence Matters

“ I effectively organized all my life around the point that sequence matters and the presence of ruin does not allow cost-benefit analyses.”
- Nassim Taleb in Skin in the Game

When 100 people visit a casino every day, and one person goes broke daily, it might seem like the chances of going broke are low, just 1%. This probability, when viewed in the context of a group, might seem comforting. However, if one person visits the casino 100 times or more, the chances of eventually going broke increase significantly. When there's repeated exposure to the "risk of ruin," group odds shouldn't be used to assess an individual's odds over time.

It's not just about isolated probabilities but also about recognizing how those probabilities stack up over time. Consider this example:

You invest 1000 in the stock market and stay invested for 30 years without making any changes. Let's assume that the market could go through three different scenarios during that time:

1. Consistent 12% for 30 years.

2. Above-average returns in the beginning, followed by below-average returns at the end, but you end with 12% CAGR.

3. Below-average returns in the beginning, followed by above-average returns at the end, but you end with 12% CAGR.

As long as there is no repetition and you invest only once, the sequence doesn’t matter. But reality is rarely like that. After all, you are most likely going to invest every year. Now, let's assume that, like an SIP, you invest 1000 at the start of every year.

Notice how the sequence impacts the outcome so drastically. So, while there is an average market return, the return you experience could vary dramatically.

Taleb beautifully explains the idea of path dependence and repeated risk of ruin when he writes “ Smoking a single cigarette is extremely benign, so a cost-benefit analysis would deem it irrational to give up so much pleasure for so little risk! But it is the act of smoking that kills, at a certain number of packs per year, or tens of thousand of cigarettes—in other words, repeated serial exposure.”

Randomness & Skill

On luck -
“People underestimate its importance except when things go badly. Then they’re very happy to ascribe it to bad luck, which it may be, of course. One has to recognize that luck plays a meaningful role in everyone’s lives. You get born to decent parents in a good part of the world, and you’re way ahead of the game. And that certainly doesn’t have much to do with skill or hard work.
- Jim Simons

There are a zillion variables impacting our lives and we don’t even know it.

For instance, when it comes to sports, children born earlier in the year often have a significant advantage over those born later due to something known as the Relative Age Effect (RAE). These older children are typically bigger and stronger than their younger peers. Consequently, they are more likely to be chosen for competitive teams, receive specialized training, and enjoy more playing time, leading to enhanced skill development. Over time, this advantage compounds, widening the performance gap between older and younger athletes within the same age group.

Crazy right? We aren’t even talking about genetics here. Forget being tall or short. Even the month you are born is impacting your life.

Most activities in life involve some amount of luck and skill. Mistaking luck for skill is where the problems begin.

Outcome = Skill + Luck

In his book "The Success Equation," Michael Mauboussin tells us that a quick way to identify the role luck plays in an activity is to see if you can lose on purpose in that activity. For instance –

1. A dentist can purposely make mistakes in his/her job and so it’s largely a skilled activity.

2. An investor in the short run may find it difficult to purposely lose money. It’s a good mix of skill and luck.

3. Snakes and Ladders is all luck as you cannot purposely lose. It’s all on the dice.

So given that we live in a world with fair share of randomness here are a few things we ought to do/be vary of -

• Alternate histories

  

  Source - Tim Urban

  In Fooled by Randomness, Taleb writes “$10 million earned through Russian roulette does not have the same value as $10 million earned through the diligent and artful practice of dentistry. They are the same, can buy the same goods, except that one’s dependence on randomness is greater than the other.”
  Given that life comes down to probabilities and the path we follow is nothing more than one of the many things that could have happened, its crucial to focus on process, especially in activities that involve a fair share of luck.

• Hindsight Bias - Hindsight bias is a psychological phenomenon that leads us to believe an event was more predictable after it has occurred than we thought before it happened. It's like saying "I knew it all along" even though we didn't really know it before."
  Want to see the bias at play? Go to Facebook and see what you posted 10 years ago. I had this vague impression of being a "somewhat cool kid," which vaporized due to the anecdotal evidence found on my Facebook timeline. (Bunch of Farmville achievements)

  This is why journaling helps. Hindsight bias prevents us from learning from our mistakes and successes, as we end up thinking that we always knew it all along. Journaling humbles us because we can go back in time and see what we were actually thinking. Did things pan out our way due to skill or luck? This is the reason why I released the Value Tortoise Investment journal.

• Survivorship Bias - Survivorship bias is a common error that occurs when we assume that success tells us the whole story. We fail to account for failures, often due to their lack of visibility. We use success stories as an example of “all the stories” and come to the wrong conclusions.

  Every football fan during the transfer season is busy on Youtube to find out which player his/her team has signed. We forget that Youtube videos are meant to showcase the best plays and highlights of a player. We don’t see the bad moments and come to faulty conclusions.

Antifragility

• If you drop a glass bowl it breaks. It’s fragile when exposed to randomness.

• If you drop a steel bowl nothing happens. It’s robust when exposed to randomness.

• Now imagine a bowl that actually gets stronger every time it is dropped. That bowl is Antifragile as it benefits from randomness.

Something that has more upside than downside when exposed to random events is said to be Antifragile.

I thought I’d touch on some of the things that make us fragile & antifragile.

• Antifragility via small stressors:
  The idea that one can live life without uncertainty, randomness, and stress is foolish. Antifragility is not the absence of stress. In fact, you need small stressors to make you more robust. Weight lifting, running, or any other exercise is actually a stressor to the body that helps one remain healthy and fit. Simply lying in bed all day without any stressors does more harm than good. Taleb gives the example of children whose parents protect them from every small stressful situation. Due to their overprotective parents, these children grow up without the ability to deal with stressful situations. Not ideal.

• Overoptimization:

  "Imagine you run a business and have set up a supplier in China. It saves you around 10% compared to a local manufacturer, so to maximize profits, you shift all your supply to China. It works perfectly for a few years, until March 2020.
  We often try to over-optimize without factoring in the idea that life can be random and unpredictable, and we need to have redundancies. As Buffett says, 'the three most important words in investing are Margin of Safety.'"

• Antifragility via Negativa:
  “People focus on role models; it is more effective to find antimodels — people you don’t want to resemble when you grow up.”
  The simplest way I tend to understand this is by inverting the problem at hand.
  - What do you want to eat? What do you not want to eat.
  - What makes you happy? What makes you unhappy?
  - What career path should I follow? What career path do I not want to follow.
  More often then not, I do find it easier answering the second question. As Charlie Munger once said “It’s not brilliance. It’s just avoiding stupidity.”

• Decentralization:

  "Taleb writes that 'Had the Titanic not had that famous accident, as fatal as it was, we would have kept building larger and larger ocean liners and the next disaster would have been even more tragic. So the people who perished were sacrificed for the greater good; they unarguably saved more lives than were lost.'
  While the single perishes, the whole system gets stronger. For a system to become antifragile, it needs to have the ability to allow single individuals or institutions to fail without dragging the whole system down. This can only be achieved through decentralization.

  The VC world, for instance, is built on trying different stuff and then if you fail, you fail. It is Antifragile as others learn from your mistakes. The banking world, on the other hand, is fragile because the collapse of one impacts the whole system, and hence, the centralization makes the system even more fragile."

• Antifragility via Lindy:
  When trying to think about what the future may look like, a good idea would be to see what has actually survived the test of time already and bet on the same. Lindy touches on the idea that things that survive the test of time have some innate robustness that may not be visible to the human eye.
  Take books as an example. If a book has survived over 50 years and is still being printed chances are it will carry on being printed for another 50 years. On the other hand, it is hard to say a book will print for another 50 years if it has only been in print for 6 months.
  When trying to write content that remains relevant for a long time, it may be easier to actually think about the past rather than the future. If people 50 years ago could perfectly understand what you wrote, chances are people 50 years later would also be able to understand the same.
  

Skin in the game

“Don’t tell me what you think, tell me what you have in your portfolio.”
- Nassim Taleb

I’d probably amend that statement to “First, tell me what you own. Then tell me why.”

Skin in the game is the simple yet crucial idea that you want to take advice from people who have something to lose if things do not pan out as they said. You want to listen to people who share not only your upside, but also your downside.

Think about professions where people share both, upside & downside.

• Pilots? Yep.

• Financial advisors? Ummm.

• Politicians? Do I really need to answer that?

That’s all for now. Hope this note has inspired you to go check out the Incerto Series by Taleb. Thank you for reading.