Nassim Nicholas Taleb (Scholar Investor) – Skin in the Game (Oct 2019)
Chapters
00:00:00 Skin in the Game: The Importance of Shared Risk
What is Skin in the Game?: Skin in the game means having something to lose if something goes wrong. In finance, it refers to having most of one’s net worth invested in the fund or business one is managing. It ensures that the managers of the fund suffer more than the investors if the fund performs poorly.
Skin in the Game as Risk Management: Skin in the game is the best form of risk management because it prevents people from hiding risks. When managers have a significant amount of their net worth invested in the fund, they are more likely to take responsible decisions and avoid excessive risk-taking. Hedge funds are better than banks and other forms of investment because they have skin in the game and are independent small units.
Benefits of Skin in the Game: It ensures that managers are aligned with the interests of investors. It promotes responsible decision-making and discourages excessive risk-taking. It leads to a cleaner and more efficient financial system.
Identifying Well-Dressed Traders and Investment Proposals to Avoid: Well-dressed traders may lack the necessary skills and experience because they rely on cosmetics rather than substance. Investment proposals that look too polished and crisp are often too good to be true and should be avoided.
00:04:40 Identifying and Avoiding Bullshit Vendors in Business and Economics
Rationality: Taleb defines rationality as the ability of something to survive. Practical success is more valuable than theoretical sense. Academics often fail to understand this distinction.
Bullshit Vendors: Bullshit vendors are individuals who lack genuine knowledge or expertise. Examples include French politicians, Paul Krugman, and Richard Thaler. They thrive in environments where they face no consequences for their actions.
Identifying Non-Bullshit Vendors: Non-bullshit vendors have something at stake and may lose money if their ideas fail. They are in touch with reality and have tangible evidence of their skills. They have skin in the game and are motivated to perform well.
Protecting Against Bullshit Vendors: To protect oneself, one should not ask bullshit vendors for advice or opinions. Instead, one should inquire about their investments or portfolio. If they lack significant exposure, their advice should be disregarded.
Honor: A Vital Concept in the Economy and Beyond: Honor is a concept that has significance in various aspects of life, including the economy. It is crucial for ethical and productive commercial transactions.
Honesty and Transparency in Commercial Transactions: In commercial transactions, people prefer to engage with those who do not shift risks to others. This ensures the system’s proper functioning. Throughout history, there have been discussions on the information that individuals should disclose during business transactions.
Collaboration and Ethical Rules in Business: The business world is highly collaborative, involving ongoing transactions rather than isolated ones. Collaborative transactions promote a non-zero-sum game, where both parties can benefit. Ethical rules, such as “my word is my bond,” are commonly observed in trading to foster trust.
Verbal Agreements and the Role of Lawyers: In real estate transactions, verbal agreements are often made, especially among certain cultural groups, such as the Ashkenazis or central London traders. The handshake is viewed as a commitment, showing strong self-respect and integrity. This is in contrast to contracts vetted by lawyers, which can be manipulated or breached.
The Handshake as a Robust Agreement: The author’s encounter with Mayor Lansky, a mobster, demonstrated that a handshake commitment was more robust than a legal contract. The handshake symbolized a sense of honor and self-respect, ensuring the agreement would be upheld.
Definition of Honor in the Market Economy: Honor in the market economy is defined as honoring commitments, avoiding nickel-and-diming tactics, and refraining from transferring excessive risks to others. Hidden risk transfer, as seen in cases like NNI, can disrupt business relationships and undermine trust.
The Currency of Trust in Long-Term Relationships: Long-term relationships and trust are essential for sustainable business success. Continuous debasement of currency, like adding “crap stuff,” can erode its value over time. Dealing with artisans who have a long-standing reputation for quality ensures reliability and customer satisfaction.
Reliability and Reputation: Building trust and reliability is crucial for maintaining a positive reputation. Offering high-quality products or services without compromising quality is essential for sustaining long-term relationships with customers. Debasing the currency or offering inferior products undermines trust and damages reputation.
Skin in the Game: Historically, people had significant skin in the game, often risking their lives or livelihoods. Limited liability has become common, but it should be limited and substantial, not minimal or non-existent. Clawback bonuses and forcing executives to invest in their companies are examples of putting skin in the game.
Risk-Taking and Society: Most people in society are calibrated, meaning they don’t take or transfer risks to others. Some individuals, like bureaucrats and opinion leaders, transfer risks to others without bearing the consequences themselves. Risk takers who protect others, such as heroes or entrepreneurs, are often admired and respected.
Entrepreneurs and Risk: Entrepreneurs can be classified into two groups: those who start companies out of passion and those who start companies to sell them. The latter group may engage in questionable practices to maximize profits, such as creating companies solely to sell them without running them effectively. Distinguishing between genuine entrepreneurs and those who game the system is important.
Barbell Strategy in Investments: The barbell strategy involves combining high-risk and no-risk investments to protect against black swan events. It is a framework for risk-taking rather than a specific recipe. The goal is to achieve a balance between taking calculated risks and preserving capital.
00:15:58 Behavioral Economics and Investing Strategies: The Critique of Nassim Nicholas Taleb
Medium Risk vs. Fund Separation: Medium risk investments are less robust than fund separation, where a high segment of funds is allocated to no-risk securities and a smaller portion to high risk. The reason is that medium risk can lead to a complete loss, while zero risk and high risk are more predictable.
Critique of Behavioral Economics: Behavioral economics fails to account for group behavior, which cannot be derived from individual behavior. Markets are nonlinear, and individual risk profiles change over time, making it impossible to consistently achieve market returns.
The Kelly-Criterion Method: The only strategy that can potentially achieve market returns is the Kelly-Criterion method, which involves adjusting investments based on risk and reward.
Wealth and Lifestyle: True wealth lies in prioritizing personal preferences and experiences over excessive wealth and complex lifestyles. Rich people often make their lives unnecessarily complicated, leading to a loss of simplicity and enjoyment.
Having Soul in the Game: “Soul in the game” refers to a profound love and passion for one’s work or craft. Artisans who have soul in the game create work that others enjoy, as their passion shines through. Disciplined and focused work is essential to maintain soul in the game, avoiding distractions like excessive emailing.
Importance of Brevity and Passion in Writing: Nassim Nicholas Taleb prefers concise emails, avoiding lengthy responses, and recommends writing books instead. Writing numerous emails can diminish the quality of writing and diminish the passion for it. Enjoying and valuing the writing process is essential to maintain a strong connection to the craft.
Example of Soul in the Game: Steve Jobs and Apple Products: Steve Jobs, the founder of Apple, emphasized the importance of aesthetics and quality in both the visible and hidden aspects of products. The inner workings of Apple products were designed to be as attractive and well-crafted as the exterior, reflecting Jobs’ commitment to excellence. Products made with care and attention to detail resonate with consumers, creating a sense of satisfaction and appreciation.
Recognizing Soul in Others’ Work: Taleb believes that the presence of soul in someone’s work can be instinctively perceived. The Japanese culture’s emphasis on detail and pride in their work serves as an example of this concept. Even simple tasks, like serving a glass of water, can be imbued with care and attention, reflecting the individual’s commitment to their craft.
Globalization and the Winner-Take-All Effect: Nassim Nicholas Taleb argues that unfettered globalization can lead to winner-take-all effects, where a small number of individuals or entities capture a disproportionate share of the benefits, while others suffer. These effects can be unfair and costly in the long run.
Protectionism to Protect Soul: Taleb suggests that some protectionism may be necessary to protect against the negative effects of globalization. This could include measures to prevent the concentration of wealth and power in the hands of a few individuals or entities.
The Value of Local Identity and Craftsmanship: Taleb highlights the importance of local identity and craftsmanship, which can be lost when economies become overly globalized. He argues that preserving these values may require some degree of protectionism.
The Importance of Sacrifice: Taleb emphasizes the importance of sacrifice in various aspects of life, including love and religion. He argues that things that are freely given are often not valued as much as those that require sacrifice. This concept applies to economic relationships as well, where cheap imports may not be as valuable as locally produced goods that require more effort and sacrifice to create.
Abstract
Risk, Honor, and Craftsmanship: The Balancing Act of Quality, Decision-Making, and Passion in Modern Economics
In the intricate web of modern economics, the principles of “skin in the game,” the significance of appearance, and the essence of craftsmanship emerge as pivotal elements. This article delves into these concepts, revealing how personal accountability and risk-taking shape financial decisions, how appearance can be misleading in professional competencies, and the profound impact of passion and craftsmanship in product quality. It contrasts the differing approaches of hedge funds and banks in risk management, critiques the superficiality of “bullshit vendors,” and emphasizes the irreplaceable value of honor and commitment in economic transactions. The article also explores the nuanced strategies of risk management and the pursuit of simplicity in wealth, ultimately weaving these themes into a comprehensive narrative that underscores the importance of authenticity and integrity in both personal and professional fields.
Main Ideas Expansion:
1. Skin in the Game: A Principle of Risk and Responsibility
The concept of “skin in the game” is central to understanding decision-making in finance. It implies that when individuals have personal stakes at risk, they are more likely to make sound decisions. This principle is exemplified in the structure of hedge funds, where personal wealth is often at stake, leading to more prudent risk management compared to banks. The article expands on how this principle applies across different sectors, highlighting the significance of personal accountability in ensuring quality and reliability.
Reliability and Reputation: Building trust and reliability is crucial for maintaining a positive reputation. Offering high-quality products or services without compromising quality is essential for sustaining long-term relationships with customers. Debasing the currency or offering inferior products undermines trust and damages reputation.
Skin in the Game: Historically, people had significant skin in the game, often risking their lives or livelihoods. Limited liability has become common, but it should be limited and substantial, not minimal or non-existent. Clawback bonuses and forcing executives to invest in their companies are examples of putting skin in the game.
Risk-Taking and Society: Most people in society are calibrated, meaning they don’t take or transfer risks to others. Some individuals, like bureaucrats and opinion leaders, transfer risks to others without bearing the consequences themselves. Risk takers who protect others, such as heroes or entrepreneurs, are often admired and respected.
2. Misleading Facades: The Role of Appearance in Professional Competence
The notion that a polished appearance in professional settings can often be misleading is explored, particularly in fields like surgery and finance. The article argues that a sleek presentation, especially in investment proposals, may mask a lack of substance and reliability, challenging the reader to look beyond superficialities.
Entrepreneurs and Risk: Entrepreneurs can be classified into two groups: those who start companies out of passion and those who start companies to sell them. The latter group may engage in questionable practices to maximize profits, such as creating companies solely to sell them without running them effectively. Distinguishing between genuine entrepreneurs and those who game the system is important.
3. Honor and Trust in Economic Transactions
The role of honor in economic transactions is critical for fostering trust and long-term relationships. The article discusses how this extends beyond legal contracts to include personal integrity and commitment, illustrating how artisans and entrepreneurs who sincerely honor their commitments build lasting trust and reputation.
Honor in the Market Economy: Honor is defined as honoring commitments, avoiding nickel-and-diming tactics, and refraining from transferring excessive risks to others. Hidden risk transfer, as seen in cases like NNI, can disrupt business relationships and undermine trust. Long-term relationships and trust are essential for sustainable business success. Continuous debasement of currency, like adding “crap stuff,” can erode its value over time. Dealing with artisans who have a long-standing reputation for quality ensures reliability and customer satisfaction.
4. Craftsmanship and the Soul in the Game
Delving into the essence of craftsmanship, the article highlights how passion and attention to detail in one’s work, exemplified by figures like Steve Jobs and in Japanese culture, resonate deeply with consumers and create a fulfilling experience for both the creator and the consumer. It underscores the idea that products made with soul and care are not only higher in quality but also more meaningful.
The Soul of the Game and Writing with Passion: Nassim Nicholas Taleb prefers concise emails, avoiding lengthy responses, and recommends writing books instead. Writing numerous emails can diminish the quality of writing and diminish the passion for it. Enjoying and valuing the writing process is essential to maintain a strong connection to the craft.
Example of Soul in the Game: Steve Jobs and Apple Products: Steve Jobs, the founder of Apple, emphasized the importance of aesthetics and quality in both the visible and hidden aspects of products. The inner workings of Apple products were designed to be as attractive and well-crafted as the exterior, reflecting Jobs’ commitment to excellence. Products made with care and attention to detail resonate with consumers, creating a sense of satisfaction and appreciation.
Recognizing Soul in Others’ Work: Taleb believes that the presence of soul in someone’s work can be instinctively perceived. The Japanese culture’s emphasis on detail and pride in their work serves as an example of this concept. Even simple tasks, like serving a glass of water, can be imbued with care and attention, reflecting the individual’s commitment to their craft.
5. Risk Management Strategies and Simplicity in Wealth
The article discusses various approaches to risk management, such as the barbell strategy, and the importance of understanding individual risk profiles. It also touches upon the concept of true wealth, suggesting that simplicity and valuing experiences over material gains lead to a more fulfilling life.
Medium Risk vs. Fund Separation: Medium risk investments are less robust than fund separation, where a high segment of funds is allocated to no-risk securities and a smaller portion to high risk. The reason is that medium risk can lead to a complete loss, while zero risk and high risk are more predictable.
Critique of Behavioral Economics: Behavioral economics fails to account for group behavior, which cannot be derived from individual behavior. Markets are nonlinear, and individual risk profiles change over time, making it impossible to consistently achieve market returns.
The Kelly-Criterion Method: The only strategy that can potentially achieve market returns is the Kelly-Criterion method, which involves adjusting investments based on risk and reward.
Wealth and Lifestyle: True wealth lies in prioritizing personal preferences and experiences over excessive wealth and complex lifestyles. Rich people often make their lives unnecessarily complicated, leading to a loss of simplicity and enjoyment.
6. Challenges of Globalization and the Need for Protectionism
Addressing the effects of globalization, the article explores the need for a degree of protectionism to preserve local industries and cultural identities. It argues that protectionism can prevent the concentration of economic benefits in a few hands and help maintain traditional ways of life.
Globalization and the Winner-Take-All Effect: Nassim Nicholas Taleb argues that unfettered globalization can lead to winner-take-all effects, where a small number of individuals or entities capture a disproportionate share of the benefits, while others suffer. These effects can be unfair and costly in the long run.
Protectionism to Protect Soul: Taleb suggests that some protectionism may be necessary to protect against the negative effects of globalization. This could include measures to prevent the concentration of wealth and power in the hands of a few individuals or entities.
The Value of Local Identity and Craftsmanship: Taleb highlights the importance of local identity and craftsmanship, which can be lost when economies become overly globalized. He argues that preserving these values may require some degree of protectionism.
7. The Value of Sacrifice in Achieving Goals
Finally, the concept of sacrifice as a necessary component in achieving both material and emotional goals is examined. This principle is illustrated in various contexts, from personal relationships to religious practices, highlighting its universal importance.
The Importance of Sacrifice: Taleb emphasizes the importance of sacrifice in various aspects of life, including love and religion. He argues that things that are freely given are often not valued as much as those that require sacrifice. This concept applies to economic relationships as well, where cheap imports may not be as valuable as locally produced goods that require more effort and sacrifice to create.
In conclusion, this comprehensive analysis brings to light the intricate interplay between risk, honor, craftsmanship, and the pursuit of simplicity in today’s economic landscape. It underscores the importance of looking beyond appearances, embracing personal responsibility, and cherishing the soul in every endeavor, whether it’s a financial investment or crafting a product. This narrative not only informs but also challenges readers to reconsider their perspectives on wealth, decision-making, and the value of authentic commitment in both personal and professional spheres.
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