and Warren Buffett
Will your portfolio survive the next "Black
a market meltdown that nobody had foreseen?
“Black Swans,” says
Nassim Nicholas Taleb in his fascinating new book, The
Black Swan: the Impact of the Highly Improbable,
are rare events (that aren’t as rare as most of us think)
— are unpredictable;
— have an enormous impact; and...
— after the event, we invent an explanation that
shows the “Black Swan” wasn’t really random,
was predictable (“if only we had looked at X, Y and/or
Z”) — or that it was actually inevitable.
Being mentally wired as explanation-seeking
creatures, having concocted our reassuring and rational story
(which is usually more wishful thinking than fact), we humans
retire to our comfortable cocoon where those devastating “statistically
improbable” “long-tail” events are once-in-a-lifetime
They’re not, says Taleb. Worse, he says, they’re
becoming more frequent.
Consider Long-Term Capital Management. The group
of highly-intelligent PhD-holding quants at LTCM, as I wrote in
Winning Investment Habits of Warren Buffett & George Soros,
had calculated “with mathematical precision”
that a market implosion that would affect all
of their positions simultaneously was a 10-sigma event; one
that might happen once in the life of the universe.
Well...duh...“Dey wuz wrong.” LTCM didn’t
even make it to its tenth birthday before it collapsed.
What you probably don’t realize is
that most other Wall Street institutions are using the same
kind of statistically-based models as LTCM...which all have
the same flaw: they don’t allow for “Black Swans.”
And then there’s...the Crash of ’87,
the rise of OPEC, the Asian currency crisis of 1997, the Russian
meltdown of 1998 (which killed Long-Term Capital Management)...two
“Black Swans” in a row!!...statistically impossible,
9/11, the incredible rise from a garage to dominance of Google,
the NASDAQ implosion of 2000...and that’s not all the “Black
Swans” that have happened over the last 30-odd years. Not
exactly “once-in-a-lifetime” occurrences.
Those investors who’ve lost billions, if not
trillions of dollars in those and similar “Black
Swans” usually put it down to “bad luck.” And
if they’re not scared away from the markets altogether,
go back to doing whatever they were doing before.
Certainly, luck can play an important part in our
lives. For example, a few weeks before the Crash of ’87
— another Black Swan — an obscure Wall Street investment
analyst named Elaine Garzarelli predicted that a crash was imminent.
After the crash she became an instant celebrity, and
has been living off her “guru” status ever since.
However, an examination of her subsequent track
record suggests that her success is due more to luck than prescience.
(For more on this, see “The
Seven Deadly Investment Sins,” which is Chapter 2 of
Investment Habits. You can download it at www.inversebooks.com).
The kind of luck most investors experience is, however,
usually bad luck. Paradoxically, one of the worst things
that can happen to a novice investor is be lucky, and
make money on his or her first investment. Convinced they
know what they’re doing, they go on to “repeat”
their success — and lose their shirts.
When the average investor makes money, he’ll
often attribute his success to his “superior ability.”
While his failures are usually the result of “bad luck.”
An examination of “good luck” usually
shows that it’s really the result of being in the right
place at the right time, knowing what to look for, and being
prepared to act instantly.
One example of this mental preparation: George Soros
was not the only currency trader to profit from the collapse of
the pound sterling in 1992 — an event which was neither
unpredictable nor unpredicted. He was, however, the only one who
went home with $2 billion dollars in profits.
The great investor structures her approach to eliminate
luck — especially “bad” luck — from her
investment method. And the impact of “Black Swans.”
Indeed, I was struck by the similarity in Taleb’s
approach with something Warren Buffett wrote in his 2006 Letter
to Shareholders. Announcing the he planned to hire “a
younger man or woman with the potential to manage a very large
portfolio, who we hope will succeed me as Berkshire’s chief
investment officer when the need for someone to do that arises,”
Picking the right person(s) will not be an easy
task. It’s not hard, of course, to find smart people,
among them individuals who have impressive investment records.
But there is far more to successful long-term investing than
brains and performance that has recently been good.
Over time, markets will do extraordinary, even
bizarre, things. A single, big mistake could wipe out a long
string of successes. We therefore need someone genetically programmed
to recognize and avoid serious risks, including those never
before encountered. Certain perils that lurk in investment
strategies cannot be spotted by use of the models commonly employed
today by financial institutions.
These two paragraphs read (and note Buffett’s
emphasis) as if they were quoted from Taleb’s book The
Of course, they weren’t. Taleb’s book
came after Buffett’s letter. And in any case, Buffett
(like Soros) was avoiding “Black Swans” long before
Taleb came up with his investment approach (based on
profiting from “Black Swans”).
That’s the important question. What’s
going to happen to your investment portfolio when the next Black
Swan hits. Are you going to lick your wounds (assuming they’re
not fatal), put it down to “bad luck” (sorry, it’s
Or will you observe the next Black Swan as something
that’s happening to other people, not you?
I urge you to read Nassim Taleb’s The
or his previous book Fooled
which — in my opinion — is the better book. It’s
also more focused on the investment world.
Or you’ll find a more “how-to”
approach in The
Winning Investment Habits of Warren Buffett & George Soros.
And re-organize your investment approach to eliminate
(or, at least, minimize) the likely effect of the next Black Swan
on your wealth (and well-being).
The problem with “Black Swans” is that
they come out of the blue and take absolutely everyone
by surprise. They’re only “predictable” with
infallible “20/20 hindsight” — which will be
a real source of comfort when you’ve gone from
being a zillionaire on top of the world to scrounging for meals
in the garbage cans in the alley-ways back of those five-star
restaurants where you used to be a regular and honored customer.
— Mark Tier
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