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What Is a Barbell Strategy? Barbell Strategy Applied To Business
A Barbell strategy consists of making sure that 90% of your capital is safe, and use 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.
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.
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 an investment advice, but rather as an educational article. For investment advice consulting an investment professional.
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 Muskis 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 modelwas 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 modelthat 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.Tim Brown, Executive Chair of IDEO, defineddesignthinking as “a human-centered approach to innovation that draws from the designer’s toolkit to integrate the needs of people, the possibilities of technology, and the requirements for businesssuccess.” Therefore, desirability, feasibility, and viability are balanced to solve critical problems.
The concept of cognitive biases was introduced and popularized by the work of Amos Tversky and Daniel Kahneman since 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 orbusinessfrom 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.
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