The Black Swan

“Past performance is not a guarantee of future returns.” – proverb

Lessons learnt: Highly improbable events have huge impacts on our lives. We are very – or exponentially – bad at predicting the future. Awareness is the first step in becoming ‘future-proof’.

If we look back on the housing bubble that was created before 2008, most of us would recognise the risk and overpricing that was going on. But back then almost no-one saw it coming, prices were rising for years and everyone had money to pay their bills. When everything eventually collapsed it put most of the world into a financial crisis of which we are only recently recovering. This kind of event is something that with hindsight we might think we may be able to predict, Nassim Taleb argues that beforehand we are totally in-the-blind. In The Black Swan, he explains why we cannot predict the future, what the impact is of highly improbable events and how we may protect ourselves from them. The book introduces groundbreaking concepts but sometimes is too long-winded.

People seek validation, in most cases, we are looking for facts that support our current models. This happens in everything from interrogation room to historical searches. Psychologists have been fascinated by this concept and have called it the ‘confirmation bias’. Before the housing boom we expected prices to keep rising, they did not. People also like to make models, we want to fit all the information that is available in the world into simple-to-understand frameworks where we can make sense of what is going on. But putting things in models also means sacrificing information for the sake of simplicity.

Nassim Taleb’s biggest problem with models is the Bell curve. A Bell curve (or Gaussian function) assumes a normal distribution, where events on the far left or right are deemed very unlikely to happen. With the Bell curve itself Taleb does not disagree, he disagrees with the interpretation. Most of the time people discount the extremes, in psychology you are even actively encouraged to not consider the outer 5%. Even in the ‘very rational’ field of Finance, investors rarely put their money up for the thing that is very unlikely to happen. Then came 9/11.

In one of the many stories mentioned in the book, Taleb describes an investor who bets on the ‘long tails’ (the outer 5%). The investor is steadily losing money, but at the same time, he knows that one of these days something very unexpected will happen, this is where he will make his money. This does not mean that the investor had the ability to look into the future, nor that he had any negative feelings towards Americans. It only meant that he saw that ‘rational’ investors were ignoring the long-tail and that he could make money there.

“Things always become obvious after the fact” – Nassim Taleb

So what is the impact of these Black Swans? They are rare, unexpected, but very big. Black Swans are events like the assassination of Franz Ferdinand, the rise of Hitler, 9/11, but also the rise of the internet, and (of course) the discovery of black swans in Australia. A Black Swan can upheaval a system that has been in place for decades (e.g. the fall of the Soviet Union) and will influence people for many years after it has taken place (all Black Swans).

Talking about unpredictable events is very interesting and difficult at the same time. After five paragraphs I have barely made it through the first part of The Black Swan. The book itself also struggles to keep the centre concepts from drifting into specifics about finance or how storytelling can take facts out of context. For the very busy people, I would advise you to read only the first part, for everyone else please do make it through the whole book. You will learn to protect yourself from negative Black Swans and in the process also learn about fake ‘experts’, Umberto Eco’s Antilibrary and randomness. Be sure to read it when convenient. ps “Remember that you are a Black Swan” – Nassim Taleb