Sometimes the best way to get ahead is to do nothing
• Investors do not always need to be trading and should not let blind faith mar decision-making
In his bestseller The Black Swan, Nassim Taleb asks us to play two thought experiments. In a section called “Travels Inside Mediocristan”, he asks us to, “Assume you round up a thousand people randomly selected from the general public and have them stand next to each other in a stadium … Imagine the heaviest person you can think of and add him to that sample. Assuming he weighs three times the average, between 400lb and 500lb, he will rarely represent more than a very small fraction of the weight of the entire population (in this case, about 0.5%).
“You can get even more aggressive. If you picked the heaviest biologically possible human on the planet (who yet can still be called a human), he would not represent more than, say, 0.6% of the total, a very negligible increase.”
In a section called “The Strange Country of Extremistan”, Taleb then asks us to, “Consider, by comparison, the net worth of the thousand people you lined up in the stadium. Add to them one of the wealthiest people on the planet — say Bill Gates, the founder of Microsoft.
“Assume his net worth to be close to $80bn, with the total capital of the others a few million. How much of the total wealth would he represent? Ninety-nine percent?”
The point Taleb is making is that in the country or domain of Extremistan, the cumulative magnitude of an outlier such as Gates is on an entirely different scale than it is in the country of Mediocristan. “In Extremistan, inequalities are such that one single observation can disproportionately impact the aggregate, or the total ... so while weight, height and calorie consumption are from Mediocristan, wealth is not.”
The key implication of this distinction is that in Mediocristan the overall impact
of an outlier is not that significant relative to the total, but in Extremistan it is enormous.
Consequently, if we are in the domain of Extremistan and we use analytical tools from Mediocristan to make predictions or when it comes to assessing risk, “we have the potential to be enormously surprised”. Some of these surprises may be positive and some may be negative, but their impact will more than likely exceed what we are prepared for.
That is not the only concern for investors when it comes to differentiating between Taleb’s two worlds. We need to be more aware that some of the things that apply in the one world don’t necessarily apply in the other, and that things that are done one way in the one world need to be done differently in the other.
Take, for example, the notion that it takes 10,000 hours to master a skill, as popularised by Malcolm Gladwell in his book
It applies in Mediocristan country but doesn’t apply in Extremistan.
In the Mediocristan world of lawyers and dentists, you can learn and eventually master your craft, but there are only so many hours you can bill, and so many cavities you can fill: consequently extraordinary success is relatively rare and takes time to achieve. Whereas in the Extremistan world of financial markets, while extraordinary success is again rare it can come suddenly, on any given day.
And while success in the Mediocristan world is typically determined by the doing or the existence of things), in the Extremistan world success can often be found through the absence of things.
As Charlie Munger says, “How many insights do you need? Well, I’d argue that you don’t need many in a lifetime. If you look at Berkshire Hathaway and all of its accumulated billions, the top 10 insights account for most of it.”
“There is the plain fool,” said Jesse Livermore, “who does the wrong thing at all times everywhere, but there is the Wall Street fool, who thinks he must trade all the time.
“No man can always have adequate reasons for buying or selling stocks daily, or sufficient knowledge to make his play an intelligent play. I proved it ... It never was my thinking that made the big money for me. It always was my sitting.”
When it comes to investing, because we underestimate the value of what we don’t know and overvalue what we do know, we misunderstand the likelihood of surprises. As Taleb says, people think intelligence is about noticing things that are relevant, but in a complex world intelligence consists in ignoring things that are irrelevant.
“One of the greatest selfdestructs [sic] of all is allowing a strongly held view to get in the way of the facts,” says Jason Zweig. “Too many investors let their blind faith in a strongly held view drive their investment decisions. They might turn out to be right, but there’s a difference between being right and making money. And the aim should be to make money.
“Which is why, approximately 99% of the time, the single most important thing investors should do is absolutely nothing.”
And if you’re still not yet convinced that the Extremistan world of Wall Street is a sort of bizarro world where things don’t always add up and common sense is not always applicable, then ask yourself this: why, when falling oil prices benefit consumers, most businesses and the economy as a whole, stock markets respond as if it’s bad news?
Serious people on various financial television programmes start to warn of a worldwide earnings collapse, deflation and rising unemployment.
Why, when layoffs are treated as bad news in the “normal” world, are they treated as good news by Wall Street?
When German industrial conglomerate Siemens said it was cutting 15,000 employees to catch up with General Electric in 2013, its share price rose by more than 20%.
The year before, when Hewlett-Packard announced an ambitious plan to slash 29,000 jobs, its share price jumped nearly 50%.
It’s this difference between Taleb’s two worlds that possibly lies behind his assertion that dentists should be in the stock market only for “entertainment”.
As he says, for those of us who’ve been reduced to transfat-less, non-smoking, politically correct ninnies, the opportunity to now and again cross over to the bizarro world of stock market investing is one of the few pleasures left to us.
NO MAN CAN ALWAYS HAVE ADEQUATE REASONS FOR BUYING OR SELLING STOCKS DAILY
THERE’ SA DIFFERENCE BETWEEN BEING RIGHT AND MAKING MONEY. AND THE AIM SHOULD BE TO MAKE MONEY