This is a review of "The Black Swan" by Nassim Nicholas Taleb. You can find all my previous book reviews here. If you're interested in buying a copy, I hope you'll consider using my Amazon Associates referral link.
"The Black Swan" captured the imagination of the reading, writing, and investing public the moment it was published in 2007, and sprang to even greater prominence as the global financial crisis ran its course over the following years. While I'd been looking forward to reading the book for some time, last month I finally found the time to plow through it.
I was disappointed.
"The Black Swan" is a book about one interesting and true observation
Taleb has one main point, which he approaches from a variety of angles: the impulse to apply Gaussian (bell curve) statistical distribution models to real-world phenomena is based on the ease of applying them, and not on their accuracy in describing those phenomena.
I took introductory statistics in college, and in my experience this is precisely correct: introductory statistics professors teach statistics as if the goal of the science is to acquire a large enough sample to discover the correct Gaussian distribution. If your sample doesn't follow a bell curve distribution, then you need to collect more samples until you discover the true, underlying bell curve.
Taleb argues convincingly that there is no reason to believe "social" phenomena have bell curve distributions. Wealth and income are not physical phenomena which become increasingly rare the further you move from the average; on the contrary, an arbitrarily large amount of income or wealth can be concentrated among an arbitrarily small number of people.
Nassim Taleb is not entirely hinged
Once you realize that Gaussian distributions are not entirely, or even not particularly, applicable to the real world, then it's natural to draw unusual conclusions.
If stock market performance is random but not Gaussian then "unusually" large stock market moves will occur far more often than would be predicted by models based on the bell curve (see: 2000 and 2008).
If success in business is random but not Gaussian then risky bets will produce extreme wins and losses more often than a bell curve would predict, so exposing yourself to those extreme wins while protecting yourself from extreme losses (Taleb's so-called "barbell" approach) will produce higher returns than a consistently mediocre portfolio.
Unfortunately, Nassim Taleb does not confine himself to his area of obvious expertise: trying to profit from large advantageous market moves while protecting himself from large, irrecoverable losses.
Taleb thinks black swans are everywhere
Taleb accidentally makes an interesting point about the difference between predicting the behavior of individual subatomic particles (completely impossible) and predicting the behavior of large grouping of subatomic particles, i.e., physical objects. He asks why, if his coffee mug is composed of subatomic particles moving in unpredictable ways, his mug doesn't leap off the desk into the air. The answer, of course, is that subatomic particles in large groups behave according to extremely predictable rules. Mugs don't jump off desks.
What Taleb gets wrong is that more human institutions are like coffee mugs than like subatomic particles.
For example, in chapter 11 Taleb advances his idea of "academic libertarianism:"
"[T]he problem with organized knowledge is that there is an occasional divergence of interests between academic guilds and knowledge itself. So I cannot for the life of me understand why today's libertarians do not go after tenured faculty (except perhaps because many libertarians are academics). We saw that companies can go bust, while governments remain. But while governments remain, civil servants can be demoted and congressmen and senators can be eventually voted out of office. In academia a tenured faculty is permanent — the business of knowledge has permanent 'owners.' Simply, the charlatan is more the product of control than the result of freedom and lack of structure."
Academia, of course, is an educational system much more like a coffee mug than a subatomic particle: the objective of higher education is to educate at a level as consistently high as possible. When people don't have control over the quality of education they receive, making it as consistent as possible is a perfectly reasonable goal.
Taleb has nothing to say about the large, functional systems we depend on
The subtitle of Taleb's book is "the impact of the highly improbable." The tendency since the book's release is to refer to any unforeseen event as a "black swan." This tendency is largely Taleb's fault, because while he has since become extremely protective of the term, in the actual text of the book it's barely defined at all. Taleb says a black swan must be "rare, impactful, and predictable in retrospect but not prospectively."
What event does that not apply to?
The fact is that vast majority of the systems actual people rely on are extremely resilient against "black swans," and virtually impossible to "hedge" against the failure of.
- Social Security is a system virtually all American workers pay into and which pays out checks to the retired and disabled.
- Medicare is a system virtually all American workers pay into and which pays out checks to doctors, hospitals, and pharmacies.
- The Department of Education's Direct Loan Program collects information on students and disburses funds to their institutions of higher education.
We can break these systems by electing politicians dedicated to destroying them. But that is not a "black swan," that's the unfortunate outcome of a process of collective decision making.
The solution to Gaussian, bell curve fantasies is not this sprawling 400-page tome of artistic criticism and intellectual wankery. It's reality.
Don't take out an interest-only mortgage with a teaser rate and balloon payment — the domestic housing market isn't Gaussian.
And don't ask more out of your investments than they're capable of giving you. Buying a low-cost total stock market mutual fund from Vanguard will give you exposure to the total stock market. Buying a bond fund will give you a stream of income. Buying a bunch of Beanie Babies will give you exposure to the 90's hobbyist market.
But there's no added value to thinking of a collapse in the US stock market, a rise in interest rates, and people realizing Beanie Babies aren't worth anything as "black swans," outside "the normal distribution." They're all guaranteed to happen eventually.
Trying to develop resilience against these events is worthwhile, but doesn't require any additional intellectual framework beyond:
- Don't risk more than you can afford to lose;
- Don't take risks you don't understand;
- Diversify what you can afford to lose among risks you understand.