Investment Strategy Part IV: Nassim Taleb: The Barbell Strategy
Maximum security and maximum risk.
Nassim Taleb is a Lebanese-born mathematician, author, philosopher, and former trader living in New York.
Taleb is famous for having written The Black Swan and Antifragile, the two most famous books of his series called The Incerto.
Recurrent themes of the books concern dealing with risk, uncertainty, asymmetry, and many other concepts that are part of the investment world.
Here’s Taleb’s strategy when it comes to investing.
The Black Swan
In traditional finance, the risk of an investment is measured by looking at its past performances.
Taleb observed, however, that this way of measuring risk was not entirely correct.
Indeed, there will be events in the future that we cannot account for because they have never happened before (called Black Swans).
As a result, past performances cannot give a reliable measure of risks.
These Black Swans furthermore have the particularity to provoke complete ruin, so investors should absolutely seek to protect themselves against them.
Taleb explains that it doesn’t matter how much and how many times you earn money in the stock market if one Black Swan (aka one crash) is enough to destroy your capital forever.
So any calculation of risk that doesn’t take Black Swans into account is false.
Since Black Swans cannot by definition be taken into account (because they have never happened before), the current risk strategy applied by banks isn’t correct or safe.
Taleb is paranoid about Black Swans because they are particularly devastating.
So he developed an investment strategy that would help him avoid them.
The Barbell Strategy
The Barbell Strategy is, like its name indicates, a strategy that works with the extreme.
The purpose is to practice super safe investment on one end, and high-risk high-reward investment on the other.
It’s like having weights at the extreme of the barbell.
In Taleb’s case, he invests 95% of his money in the safest assets possible where the capital will be protected even in the case of a Black Swan.
These assets are gold, US Treasury bonds, or simply, cash.
Since these assets are really safe, they yield little money.
Now that the majority of his capital is safe, he can invest the remaining 5% into high-risk high-yielding assets, such as investments in young companies, for example.
This strategy ensures that he wins no matter what. If his 5% goes to waste, he still has 95%. If the 5% helps him make money, then it’s a bonus.
What About the Middle Ground?
What about stocks, foreign bonds, or real estate?
Beware of these assets.
They yield little compared to their real risk rate.
Because of Black Swans.
More than one investors have lost their entire savings in the collapse of “safe” big companies.
Enron, General Motors, or Lehman Brothers are only a few examples.
Notice how these investments yielded maybe 5–12% a year, but were as risky as a startup investment which could yield 100X — or more.
12% return with a risk of bankruptcy isn’t worth it.
If you risk losing your entire capital, aim at a possible return of 100X.
If you want a real safe investment, then it’s the 1%-yielding asset.
Conclusion on Nassim Taleb
The Barbell Strategy does not exist to maximize one’s net worth, but one’s peace of mind.
When you know your money is safe, you can go to sleep peacefully — which is something Taleb considers to be priceless.
The particularity of Nassim Taleb’s investment strategy is that it’s not an investment strategy that will help people become rich. It’s an investment strategy that will help them stay rich.
One needs to be already rich in order to benefit from such a strategy.
Conclusion of this Mini-Series
During the last four weeks, we’ve had a look at four different investment strategies.
Peter Thiel looked for the best startup that was likely to multiply the original investment by the biggest factor possible. His bets were highly concentrated.
Warren Buffett did the same, but with undervalued companies that had already shown they were likely to be good bets. His investments weren’t as concentrated as Thiel’s, but were far from diversified still.
Ray Dalio took a macro-perspective to invest in assets that have already risen in the past when such and such events happened. His investments are widely diversified as he does not look to earn as much as he tries not to lose any money.
And Nassim Taleb simply invests 95% of his money in ultra-safe assets which enables him to sleep well, and 5% in high-risk, high-yield assets that may provide him with great returns.
All of these strategies work. They all depend on what you want to do with your money.
The first two investors want to maximize their returns. The last two investors want to minimize their losses.
One of the best assets to simultaneously maximize returns while minimizing risk and losses is farmland. Farmland is one of the very few assets that is low-risk and high-yield due to its intrinsic economics.
Unlike all other assets, the value of farmland does not depend on the economy but on the supply and demand for the land, and on the demand for the food it produces.
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