Six Reasons I am Not Nassim Nicholas Taleb and Neither Are You
“You find peace by coming to terms with what you don’t know.”
–Nassim Nicholas Taleb
Imagine yourself in a room with 99 other average people. What’s the average weight? If you’re a male, it’s 191 pounds. If you’re a female, it’s 164.3 pounds. What happens to the average weight if you add the world’s heaviest male or female to the room? The heaviest male weighed 1,400 pounds. The heaviest female weighs 643 pounds. For men, the average weight would go up to 203 pounds, a 6.3% increase, and for women, the average weight would go up to 169 pounds, a 2.9% increase.
Now, do the same thing for measuring wealth. The average family net worth is $77,300. Drop Carlos Slim into the room. He’s worth $69 billion. You’ve now increased the average net worth in the room to approximately $683 million, or a roughly 880,000% increase.
This exercise is outlined in the book The Black Swan by Nassim Nicholas Taleb. He discusses how we are very good at averaging things out, but terrible at identifying the extreme outliers. Furthermore, we underestimate the actual probability and magnitude of outliers which will positively or negatively impact us.
Think about how the lottery works. The theme of the lottery is “someone has to win, so why not you?” The lottery officials and the media trot out the winners to make them seem like they’re everyday people and that there are lottery winners everywhere. People fall victim to recency bias and go out and buy lottery ticketswith the expectation that it’s going to be them. They think that the chances of winning are actually much better than the mathematics reveal them to be. The blind spot of evaluating black swans shows itself.
Taleb ran a hedge fund through his company Empirica Capital seeking to take advantage of the blind spot that we have for black swans. The idea was to make many small bets on outliers where the magnitude of the outlier would be enormous. His firm invested in call and put options where, according to their calculations, impact of outlier * probability of outlier > price of option.
If you read the book, the strategy seems simple. Michael Lewis tells of a story in The Big Short where a couple of guys pooled all of their money together, approximately $100,000, made two consecutive options purchases based on similar thinking, and became multi-multi millionaires. Suddenly, the idea is reinforced in your head. Two guys, one phone call, one meeting, and boom! Gulfstream, here I come!
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Jason Hull is a Fort Worth fee only, hourly financial planner who serves clients in Fort Worth, TX and Dallas, TX as well as serving clients nationwide.
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