A Barbell strategy consists of making sure that 90% of your capital is safe, and using the remaining 10%, or on risky investments. Applied to business strategy, this means having a binary approach. On the one hand, extremely conservative. On the other, extremely aggressive, thus creating a potent mix.
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Barbell strategy in a nutshell
A Barbell strategy, a la Taleb consists of making sure that 90% of your capital is safe, by investing it in Risk-Free assets, which cover from inflation. On the other hand use 10%, or the remaining capital for very risky investments.
Few people can coin a new word, and one of those is the options trader, writer, and philosopher Nicholas Nassim Taleb. He introduces the concept of Black Swans and how to deal with that in his three books series called “Incerto.”
Before men discovered the existence of Black Swans in Australia, empirical evidence showed that they did not exist.
The problem with empirical evidence is that it can only be falsified rather than prove to be right or wrong ultimately. In other words, there will be not a final theory in science, or in socio-economical life, that will be right forever.
Instead, a method that works better compared to the previous ones. Until a new, evolved theory, therefore falsify a previous one. It does not mean that the former assumption was wrong, but rather not as complete as the new theory.
What does this introduction have to do with investing? The investing world is plenty of gurus, which affirm to be able to read the markets.
The problem is that this is not possible, not because they are not knowledgeable enough but somewhat because they are too indoctrinated with their theories and, therefore, they fall into the narrative fallacy.
The narrative fallacy is a bias that we all carry, but that the so-called “experts” seem to carry the most.
In other words, we tend to give an explanation and create cause-effect relationships between events, which are not related at all. In short, with words we can create stories, those stories fit a narrative, which is deviant from reality.
Also, while experts in the domain of physical things, maybe really able to have a better understanding of that domain, this is not the case for social areas.
As Taleb puts it,
“if you put 1000 people in line and you take the person who weighs the most in the world, that person will represent thirty basis points of the total (0.30% of the total);”
instead, if you take 1000 people and you want to measure how the wealthiest person in the world will affect the total, you will be astonished to see that person representing 99.9% of the total.
Mediocristan vs. Extremistan
In other words, Taleb classifies our world in two domains, a first domain, called Mediocristan, like the weight example. And a second domain, called Extremistan, like the wealth example.
In the weight example (mediocristan), one single rare event minimally impacts the total. In the wealth example (extremistan), instead, one single rare event will make the total. From here, we go back to our idea of black swans.
Socio-economics is classifiable as an extremistan domain, where one rare event can make the total. Therefore, the problem here is to understand the difference between rare events, or “Black Swans” which can be classified in “Positive Black Swans” and “Negative Black Swans.”
In other words, we want to avoid negative black swans, while we want to completely expose ourselves to positive black swans. But how does this concept apply to finance and investments?
To take advantage of positive swans while avoiding negative ones, you have to take an opposite approach in the same domain. In short, you want to cover yourself from blowups while also making yourself exposed to unlimited upsides.
The barbell strategy
This strategy translates into the Barbell strategy, elaborated by Taleb. This strategy mainly consists of making sure that 90% of your capital is safe, by investing it in Risk-Free assets, which cover from inflation. On the other hand use 10% of the remaining capital for very risky investments.
Risky investments such as options, or rights but not obligations to either buy or sell a stock in the future. The cool thing about options is the fact that you know the downside beforehand (the cost of the option), although, you don’t know the upside (as Taleb puts it “The sky is the limit”).
While this strategy can be used in investing, it can also be used in other domains of life. The interesting theory coming from Taleb’s book is intriguing since it can be expanded to the point of making yourself “antifragile” to life.
This new word coined by Taleb differs from robustness. Indeed, while robust things are resistant, “antifragile” things, gain from disorder. In an uncertain, extremistan world, becoming antifragile can be the answer and solution to life’s meanest problems.
The Four-Week MBA is an online community. The article above is not meant as investment advice, but rather as an educational article. For investment advice consult an investment professional.
The barbell strategy in business to manage innovation bets
Technological modeling is a discipline to provides the basis for companies to sustain innovation, thus developing incremental products. While also looking at breakthrough innovative products that can pave the way for long-term success. In a sort of Barbell Strategy, technological modeling suggests having a two-sided approach, on the one hand, to keep sustaining continuous innovation as a core part of the businessmodel. On the other hand, it places bets on future developments that have the potential to break through and take a leap forward.
The barbell strategy can be translated into business and in high-tech businesses, to place proper technological bets, and, therefore, evolve a business model strategy.
When it comes to business model innovation, thanks to the barbell approach, we can run two types of bets and business buckets:
Continuous improvement of the core business model
That is a process that requires a continuous feedback loop to develop a valuable product and build a viable businessmodel. Continuous innovation is a mindset where products and services are designed and delivered to tune them around the customers’ problems and not the technical solution of its founders.
Maintaining the primary business model is critical, and in today’s business world, where software rules, it requires a substantial amount of resources.
Also, seemingly asset-light companies, like Google, who are software-first, need to spend billions per year to keep improving their core products at scale.
This is one side of the barbell, the conservative one.
Unrelated bets
On the other hand, you want to plug into your businessmodel – seemingly unrelated bets – that not only are not tied to the primary business model but that, over time, can swallow it all!
Take the case of how Apple, over the years, has swallowed its most successful products, from the iPod to the iPad, to create an industry based on the iPhone.
Thus, placing these speculative bets is critical to potentially creating larger and larger market opportunities; while they have the potential of cannibalizing their businessmodel, they can evolve into something new, larger, and more in line with the future business context.
The drawbacks of standardized metrics
Taleb explains why standardized statistical metrics, used by some, are worthless.
The most common mistake is seen in equity portfolios.
Some investors opt to, on the one side, stack with aggressive high beta equities, while the other could be populated with defensive low beta equities.
Believing that they are conveyed according to a barbell strategy.
Note that the term “beta” measures how much equity moves relative to its index.
For American investors, this tends to be either the S&P 500, Dow Jones, or NASDAQ.
If the NASDAQ increased by 3% and the stock increased by 12%, it has a relatively high beta value of 4.
In other words, it moves four times as much relative to its index.
A more defensive stock may have a beta value of 0.4, which means it may only move 40% as much as the underlying index in either direction.
Some stocks also possess negative betas. This means they go down when the index is up and vice versa.
In fact, Beta is not only a flawed financial metric, but it’s also a misleading one.
If you’re using Beta, CAPM, or WACC to barbell out your financialstrategy, you’re doing it all wrong!
In finance, the capital asset pricingmodel (or CAPM) is a model or framework that helps theoretically assess the rate of return required for an asset to building a diversified portfolio able to give satisfactory returns.
Key Highlights of the Barbell Strategy:
Origin and Concept: The Barbell Strategy, introduced by Nicholas Nassim Taleb, involves allocating 90% of capital to safe, low-risk assets and 10% to high-risk investments. This binary approach aims to balance extreme conservatism with aggressive risk-taking.
Black Swans and Empirical Evidence: Taleb’s concept of Black Swans refers to rare, unexpected events that have a profound impact on systems. The strategy is based on acknowledging the limitations of empirical evidence and the difficulty of predicting such events.
Mediocristan vs. Extremistan: Taleb categorizes the world into Mediocristan, where rare events have minimal impact, and Extremistan, where rare events significantly influence outcomes. Socio-economics falls into Extremistan, which necessitates managing exposure to both positive and negative Black Swans.
Positive and Negative Black Swans: The strategy aims to avoid negative Black Swans while exposing oneself to positive ones. This involves being protected against catastrophic events while benefiting from significant upside potential.
Barbell Strategy in Finance: In finance, the Barbell Strategy suggests allocating 90% of capital to risk-free assets that cover inflation and using the remaining 10% for highly risky investments, such as options. The strategy offers a limited downside and potentially unlimited upside.
Antifragility: Taleb’s concept of “antifragility” goes beyond robustness by suggesting that systems can benefit from disorder. The Barbell Strategy, in an uncertain world, helps individuals and systems become antifragile and thrive in the face of challenges.
Business Application: The Barbell Strategy can be applied to businessinnovation. It involves maintaining continuous improvement in the core business model while also making unrelated bets on breakthrough innovations. This approach balances stability with the potential for significant leaps forward.
Continuous Improvement and Unrelated Bets: The conservative side of the business Barbell Strategy focuses on continuous improvement of the core businessmodel. The aggressive side involves placing speculative bets on potentially disruptive innovations that can reshape the industry.
Drawbacks of Standardized Metrics: Taleb criticizes the use of standardized metrics like Beta, CAPM (Capital Asset Pricing Model), and WACC (Weighted Average Cost of Capital) in financial strategies. These metrics are considered flawed and misleading when applying the Barbell Strategy.
Antifragility was first coined as a term by author, and options trader Nassim Nicholas Taleb. Antifragility is a characteristic of systems that thrive as a result of stressors, volatility, and randomness. Therefore, Antifragile is the opposite of fragile. Where a fragile thing breaks up to volatility; a robust thing resists volatility. An antifragile thing gets stronger from volatility (provided the level of stressors and randomness doesn’t pass a certain threshold).
The Lindy Effect is a theory about the ageing of non-perishable things, like technology or ideas. Popularized by author Nicholas Nassim Taleb, the Lindy Effect states that non-perishable things like technology age – linearly – in reverse. Therefore, the older an idea or a technology, the same will be its life expectancy.
Ergodicity is one of the most important concepts in statistics. Ergodicity is a mathematical concept suggesting that a point of a moving system will eventually visit all parts of the space the system moves in. On the opposite side, non-ergodic means that a system doesn’t visit all the possible parts, as there are absorbing barriers
Technological modeling is a discipline to provide the basis for companies to sustain innovation, thus developing incremental products. While also looking at breakthrough innovative products that can pave the way for long-term success. In a sort of Barbell Strategy, technological modeling suggests having a two-sided approach, on the one hand, to keep sustaining continuous innovation as a core part of the businessmodel. On the other hand, it places bets on future developments that have the potential to break through and take a leap forward.
First-principles thinking – sometimes called reasoning from first principles – is used to reverse-engineer complex problems and encourage creativity. It involves breaking down problems into basic elements and reassembling them from the ground up. Elon Musk is among the strongest proponents of this way of thinking.
The ladder of inference is a conscious or subconscious thinking process where an individual moves from a fact to a decision or action. The ladder of inference was created by academic Chris Argyris to illustrate how people form and then use mental models to make decisions.
The Six Thinking Hats model was created by psychologist Edward de Bono in 1986, who noted that personality type was a key driver of how people approached problem-solving. For example, optimists view situations differently from pessimists. Analytical individuals may generate ideas that a more emotional person would not, and vice versa.
Second-order thinking is a means of assessing the implications of our decisions by considering future consequences. Second-order thinking is a mental model that considers all future possibilities. It encourages individuals to think outside of the box so that they can prepare for every and eventuality. It also discourages the tendency for individuals to default to the most obvious choice.
Lateral thinking is a business strategy that involves approaching a problem from a different direction. The strategy attempts to remove traditionally formulaic and routine approaches to problem-solving by advocating creative thinking, therefore finding unconventional ways to solve a known problem. This sort of non-linear approach to problem-solving, can at times, create a big impact.
Moonshot thinking is an approach to innovation, and it can be applied to business or any other discipline where you target at least 10X goals. That shifts the mindset, and it empowers a team of people to look for unconventional solutions, thus starting from first principles, by leveraging on fast-paced experimentation.
The concept of cognitive biases was introduced and popularized by the work of Amos Tversky and Daniel Kahneman in 1972. Biases are seen as systematic errors and flaws that make humans deviate from the standards of rationality, thus making us inept at making good decisions under uncertainty.
Bounded rationality is a concept attributed to Herbert Simon, an economist and political scientist interested in decision-making and how we make decisions in the real world. In fact, he believed that rather than optimizing (which was the mainstream view in the past decades) humans follow what he called satisficing.
The Dunning-Kruger effect describes a cognitive bias where people with low ability in a task overestimate their ability to perform that task well. Consumers or businesses that do not possess the requisite knowledge make bad decisions. What’s more, knowledge gaps prevent the person or business from seeing their mistakes.
Occam’s Razor states that one should not increase (beyond reason) the number of entities required to explain anything. All things being equal, the simplest solution is often the best one. The principle is attributed to 14th-century English theologian William of Ockham.
The Mandela effect is a phenomenon where a large group of people remembers an event differently from how it occurred. The Mandela effect was first described in relation to Fiona Broome, who believed that former South African President Nelson Mandela died in prison during the 1980s. While Mandela was released from prison in 1990 and died 23 years later, Broome remembered news coverage of his death in prison and even a speech from his widow. Of course, neither event occurred in reality. But Broome was later to discover that she was not the only one with the same recollection of events.
The bandwagon effect tells us that the more a belief or idea has been adopted by more people within a group, the more the individual adoption of that idea might increase within the same group. This is the psychological effect that leads to herd mentality. What in marketing can be associated with social proof.
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
