This article originally published in The Northern Daily Leader on 16 August 2014.
One of the most interesting writers to emerge in the field of finance in recent years is Nassim Nicholas Taleb. Taleb has managed to forge a successful, if controversial, career in literature, following on the back of a long stint as a derivatives trader on global equity, commodity and currency markets. Taleb’s first book, Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets was a critique of our ability to correctly understand randomness and its impacts, both on a daily basis and also in regards to investing. Taleb believes that we tend to discount the probability of severe negative events occurring – an approach akin to old line about ‘picking up pennies in front of a bulldozer’. It’s all very well making a small steady return, but when things go horribly wrong it ends really badly (i.e. you get squashed by the bulldozer). As an example, Taleb described financial option sellers as people who “eat like chickens and go to the bathroom like elephants”, meaning that they earn a small steady living selling options but when it goes wrong it’s a huge disaster. Taleb’s view was that we ignore the unknown and unforeseeable events and focus too much on those events we can predict with greater certainty, erroneously believing we understand and can predict all outcomes. Taleb advocates an investment approach which allows you to benefit from a ‘fat tail’ event (an extreme event with a low probability of occurring, but a large payoff – taken from the description of a non-normal distribution as ‘fat-tailed’).
In essence, Taleb believes in an investment approach which entails putting the majority of your money in the safest inflation-linked investment you can find (US Treasury Inflation-Protected Securities probably) and a small amount in an outrageous bet which will make an obscene amount if the sky ever falls in. There is a certain attractiveness to this approach – you can be confident that your money is safely invested, and when financial disaster does strike, your 1-in-1000 bets will pay off handsomely and you can start thinking about what colour to paint your private jet. The problem for most people however, is that the safest inflation-linked investment you can find is not going to generate much money for you to live off (a recent sale of such US Treasuries was done at a yield of 0.249% – even the interest on a bank savings account is higher than that) and the timing of the great money-making event is uncertain itself. Yes it may be coming, but you may run out of money long before your low-probability but high-payoff bet ever comes off. Taleb’s books are an entertaining read (if you can see past the machismo, self-aggrandizing and thinly-veiled insults which occasionally threaten to crowd out the good bits), but it’s no investment guide for retirees.