Nassim Taleb is one of the pre-eminent thought leaders in the world. He often espouses views that seem contradictory on the surface, but have stood the test of time. Before publishing best-sellers Fooled by Randomness, The Black Swan, and Antifragile, Taleb was a trader who made millions betting on rare and consequential market events -- like Black Monday of 1987.
Taleb's next book, Skin in the Game, won't officially be released until the end of February 2018. But because he publishes his drafts for everyone to see on Medium, I've already read all that's available. While the topics covered are wide-ranging, I've picked out five lessons that every investor can learn from Taleb.
The market's returns will not be your own
Building assumptions into your financial plan based on historical market returns can be a dangerous proposition.
"If the investor has to eventually reduce his exposure because of losses, or because of retirement, or because he remarried his neighbor's wife, or because he changed his mind about life, his returns will be divorced from those of the market, period."
This underscores two important points: you need an emergency fund to cover expenses for six months without income, and you should never invest money you think you'll need within the next five years. Without these two things, you'll have "uncle points" -- times when you'll cry "uncle," take your money out of the market, and reduce your returns in the process.
Most cognitive biases are not cognitive biases at all
We hear lots of words bandied around like "loss aversion," "anchoring bias," and the like to help us explain why we make investing errors. To that, Taleb simply says: "I believe risk aversion does not exist."
By that, he means that our entire definition of rationality is backwards. We carry out tests with single variables in laboratory settings, and then extrapolate the results to the real world. That's where we run into trouble. Over eons of evolution, those who were "risk averse" -- and thus, "irrational" by our standards today -- had a higher probability of surviving and passing their genes along.
This leads to a startling conclusion:
"Rationality is not what has conscious verbalistic explanatory factors; it is only what aids survival, avoids ruin. Rationality is risk management, period."
Speaking specifically about stocks, Taleb continues:
"The market is like a large movie theatre with a small door. And the best way to detect a sucker (say the usual finance journalist) is to see if his focus is on the size of the door or on that of the theater."
This harkens back to the first point: if you don't have the redundancy of emergency savings and extra cash on hand, you'll be forced to try and run through that tiny door during a downswing -- and the effects on your portfolio will be lasting.
But risk is actually OK -- as long as it doesn't lead to ruin
But, critically, that does not mean we should never take risks. It means that we should never take the type of risks that can lead to ruin. Instead, we should keep our mistakes small enough to avoid ruin, but big enough to learn from.
"Jumping from a bench would be good for you and your bones, while falling from the twenty-second floor will never be so. Small injuries will be beneficial, never larger ones. Fearmonging about some class of events is fearmonging; about others it is not. Risk and ruin are different tings [sic]."
That's where Taleb's "barbell strategy" to investing comes in, which you can read more about here.
Two things to look for: simplicity and skin in the game
We are naturally attracted to complex solutions to our financial problems. That's because we often confuse "simple" with "easy." The basic mechanics of getting rich are simple: live well below your means, save and invest the difference. That's it. The problem with that: it's tough to sell books about investing if your strategy is so simple!
"People who are bred, selected, and compensated to find complicated solutions do not have an incentive to implement simplified ones...Never pay for complexity of presentation when all you need is results."
This is why it's always important, here at the Fool and elsewhere, to check out the disclosures at the bottom of every article -- and the CAPS profile of the author. If someone has done a magnificent job of weaving together a story stock's narrative, but hasn't made a public call on it, or own it themselves, or they don't have a solid track record, it's worth thinking twice before taking the advice.
What's the point of being rich anyway?
In Taleb's world, freedom is the ultimate goal, not being rich. That's why he prefers to be referred to as a "flanuer" these days: an idler or lounger. He has a host of quotes in the book about not falling into the hedonic trappings of wealth. Here are some of my favorites:
- "When people get rich...[t]hey lose control of their preferences, substituting constructed preferences to their own, complicating their lives unnecessarily, triggering their own misery."
- "Most people, I am convinced, are happier in close quarters, in a real barrio-style neighborhood, where they can feel human warmth, have company, but when they have big bucks they end up pressured to move into a outsized impersonal and silent mansions, far away from the neighbors. [sic]"
- "You can define a free person precisely as someone whose fate is not centrally or directly dependent on his peer assessment."
All of these lessons can help us become better investors, and focus our reasons for wanting that outcome in the first place. Though I've read all that's posted online, I'll still be visiting my library to get a copy come March. You should consider doing the same.
The Motley Fool has a disclosure policy.