On the side (of web design and development, teaching, etc) I like to read and think about investing.  The Intelligent Investor is my favorite book on investing, written by the brilliant man Benjamin Graham.  The reason it is my favorite book is that it makes practical sense to me.  It seems wise.  It rails against speculation.  It is about as conservative and grounded an investing strategy as you can get.

As I read through Taleb’s The Black Swan, I recognized an idea that is complementary.  It is all about limiting your risk to the unknown – which is really what Graham was getting at.  Here’s Taleb’s approach:

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 hyper conservative and hyper aggressive as you can 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 85-90 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-syle 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 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.

The Black Swan, pages 205-206

In addition to it’s application to investing, this idea can be applied to life.  And, indeed, Taleb details what that might look like at a later point in the book.  But the idea is to be conservative in your job, in your pursuits, etc with all but 10-15 percent of your life.  In that other 10-15 percent you take risks that have maximum upside.  As in, look for opportunities that “scale” (as a business person might say).  You look for things that allow you to input some amount (time, money, etc) but can return gains that are non-proportional.  I can put this idea in the negative better than the positive: if you plan on making widgets, your earnings will always be proportional with the number of widgets you make.  Sure, you may be able to raise the price, but you will always have to work harder to make more widgets and make more money.  If, instead, I could write a book, there’s a chance that book will sell millions of copies (*cough* Harry Potter *cough*) and give me a disproportionate return.  As in, I write one book which takes me x hours (say 200 hours).  The more books I sell, the more I make for those 200 hours – I do not (necessarily) need to work more hours to make more money.  David Heinemeier Hansson from 37 Signals talks about this same idea.

Anyway, it’s a very interesting idea to me and I wonder how this might apply to both my career and my investments.

On pages 58-59 of The Black Swan, Nassim Nicholas Taleb talks about an experiment by P.C. Wason.  Wason gave his subjects a number sequence – 2, 4, 6 – and asked them to try to guess the rule that generates the sequence.  In order to guess the test subjects produced other three-number sequences.  They were ten told “yes” or “no” depending on whether or not their sequences fit the rule.  The correct answer was “numbers in ascending order” but very few people got it right.  In order to see the rule, people would have had to provide number in descending order, or out of order – but very few people tried those sequences.  Generally, the subject would come up with a hypothesis of what they thought the rule might be and try to confirm it through their guesses.  Taleb goes on…

But there are exceptions.  Among them figure chess grand masters, who, it has been shown, actually do focus on where a speculative move might be weak; rookies, by comparison, look for confirmatory instances instead of falsifying ones. But don’t play chess to practice skepticism.  Scientists believe that it is the search for their own weaknesses that makes them good chess players, not the practice of chess that turns them into skeptics.  Similarly, the speculator George Soros, when making a financial be, keeps looking for instance that would prove his initial theory wrong.  This, perhaps, is true self-confidence: the ability to look at the world without the need to find signs that stroke one’s ego.

What’s interesting about all of this is my own perspective.  I find myself wanting to ignore the negative.  I want to dodge the weak points in my speculations.  Rather, I want to bolster my own confidence, my own ego by proving that my way is right.  When, in reality, I would go further faster if I failed faster by shooting down my own ideas.  Oh to be that self-confident.