What is the barbell strategy? What is a barbell investing approach? How can you adopt the barbell strategy to mitigate risk in investing and in life?
The “barbell strategy” is an approach designed to minimize the pain of a negative event while, potentially, reaping the benefits of a positive event. The barbell strategy is commonly used in investing, but it’s also applicable to life more generally.
We’ll cover the nature of the barbell strategy and other strategies for mitigating risks.
Adopt the “Barbell Strategy”
When Nassim Nicholas Taleb was a trader, he pursued an idiosyncratic investment strategy to inoculate himself against a financial Black Swan. He devoted 85%–90% of his portfolio to extremely safe instruments (Treasury bills, for example) and made extremely risky bets—in venture-capital portfolios, for example—with the remaining 10%–15%. (Another variation on the strategy is to have a highly speculative portfolio but to insure yourself against losses greater than 15%.) The high-risk portion of Taleb’s portfolio was highly diversified: He wanted to place as many small bets as possible to increase the odds of a Black Swan paying off in his favor. This is an example of a barbell investment strategy.
The “barbell strategy” minimizes the pain of a negative Black Swan while, potentially, reaping a positive Black Swan’s benefits. If the market collapses, a person pursuing this strategy isn’t hurt beneath the “floor” of the safe investments (say, 85%), but if the market explodes, he has a chance to capitalize by virtue of the speculative bets.
(Shortform note: There is, of course, the possibility that a Black Swan will affect even the safest investment—in fact, if we take Taleb at his word, there is no such thing as a safe investment.)
Other Ways to Mitigate Risk
Prepare, Don’t Predict
The barbell approach isn’t the only way to mitigate risk in investments and in life. Because Black Swans are, by definition, unpredictable, we’re better off preparing for the widest range of contingencies than predicting specific events.
That’s because, though Black Swans themselves can never be predicted, their effects can be. For example, no one can predict when an earthquake will strike, but one can know what its effects will be and prepare adequately to handle them.
The same goes for an economic recession. No one can predict precisely when one will occur, but, using the “barbell strategy” or some other means of mitigating risk, we can at least be prepared for one.
Maximize Possibilities for Positive Black Swans
Although the most memorable Black Swans are typically the negatively disruptive ones, Black Swans can also be serendipitous. (Shortform note: Love at first sight is undoubtedly a Black Swan.)
Taleb advocates (1) sociability and (2) proactiveness when presented with an opportunity as strategies for opening ourselves up to positive Black Swans. Sociability puts us in the company of others who may be in a position to help us—we never know where a casual conversation might lead. And proactiveness—taking up a successful acquaintance on an invitation to have coffee, for example—ensures we’ll never miss our lucky break. This is another way of using the barbell strategy.
Distinguish Between Positive Contingencies and Negative Ones
Different areas of society have different exposure to Black Swans, both positive and negative.
For example, scientific research and moviemaking are “positive Black Swan areas”—catastrophes are rare, and there is always the possibility of smashing success. The stock market or catastrophe insurance, meanwhile, are “negative Black Swan areas”—upsides are relatively modest compared to the possibility of financial ruin.
It’s important to note that the history of a negative–Black Swan area will underrepresent the possibility of catastrophe. An obvious example is financial markets, which always appear stable until they crash. Positive–Black Swan areas, oppositely, will underrepresent the possibility of serendipity: Despite years of research, a cure for cancer hasn’t been found; but one could be found any day. In order to mitigate risk and employ the barbell strategy, it’s important to know where the biggest risks lie.
Suffice it to say, we should take more risks in a positive Black Swan area than in a negative Black Swan one.
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