Against the barbell strategy

post by Benquo · 2018-09-20T15:19:08.185Z · score: 21 (20 votes) · LW · GW · 16 comments

This is a link post for http://benjaminrosshoffman.com/against-barbell-strategy/

Nassim Nicholas Taleb recommends that instead of the balanced portfolio of investments recommended by portfolio theory, we follow a "barbell" strategy of putting most of our assets in a maximally safe, stable investment, and making small, sustainable bets with very high potential upside. If taken literally, this can't work because no such safe asset class exists.

Taleb typically uses US treasury bonds as an example of an extremely safe asset. This can only be true metaphorically. They are extremely safe if your measure of value is denominated in US dollars. But of what use to me are US treasury bonds in a hurricane, or if the US dollar collapses? Of what use if people like me become targets for state persecution, stripped of our financial assets or ability to access them? Of what use if I'm trying to deal with a spiritual or health problem and don't know how to find competent advice? If I'm trying to feed myself and don't know how to distinguish profit-seeking propaganda or engineered taste from genuine information about which foods are healthful?

Risks, and opportunities, are many-dimensional. And along very few dimensions is there anything like the sort of crystalline perfection of a treasury bond. A personal network extending to a variety of fields can do a lot to help you avoid getting scammed, and get access to at least an ordinary standard of competence, such as it is. A friend with different interests and skills from yours will do a lot to expand the access you have, and the skills and knowledge at your disposal. Friends from different cultures or communities can serve as an important hedge if you and people like you become a target of extraction or persecution for some reason, or simply if your way of life becomes unsustaintable.

Land you are used to occupying and know well is easier to robustly possess and develop than a rented apartment (but the upside is often higher in high-density areas, which is why young people often prefer them). A spouse makes it easier to pool assets into a venture diversified between building up a single household and seeking external trade or mercenary opportunities. And children who grow up well-adjusted to the world can be helpful if you need to navigate a changing incentive landscape when you've already committed your assets to a bunch of permanent bets (which you need to do, since time is limited). In addition, they may be a decent consolation prize if cryonics doesn't work to ensure your personal survival. Intergenerational communities of interest protect you a lot more day to day, though they themselves can have trouble reallocating resources in changing circumstances.

Risk cannot be avoided, only managed. The risk-free asset is an illusion. Someday your natural life will end, you need to invest taking that into account, and taking into account that this is true of everything else on this earth that you can put your trust in. If you allocate too much of your portfolio to "safe" assets you're leaving yourself unnecessarily exposed to the risk that this asset will become irrelevant, and failing to take the chances that are actually available to improve your position.

To a large extent, young people do well in the long run by pursuing things that are genuinely fun but not universal. This engages our natural sense of opportunity, which doesn't understand formal systems like money very well, but understands very well how to look for high-upside bets that are actually good for us. I wish someone had explained this to me fifteen years ago. If this advice helps you, then think of me when you're successful, and remember that I didn't charge you for it at the time. And remember to pay it forward.

Or, as Ecclesiastes says:

Cast thy bread upon the waters: for thou shalt find it after many days.
Give a portion to seven, and also to eight; for thou knowest not what evil shall be upon the earth. If the clouds be full of rain, they empty themselves upon the earth: and if the tree fall toward the south, or toward the north, in the place where the tree falleth, there it shall be. He that observeth the wind shall not sow; and he that regardeth the clouds shall not reap. As thou knowest not what is the way of the spirit, nor how the bones do grow in the womb of her that is with child: even so thou knowest not the works of God who maketh all. In the morning sow thy seed, and in the evening withhold not thine hand: for thou knowest not whether shall prosper, either this or that, or whether they both shall be alike good. Truly the light is sweet, and a pleasant thing it is for the eyes to behold the sun: But if a man live many years, and rejoice in them all; yet let him remember the days of darkness; for they shall be many. All that cometh is vanity. Rejoice, O young man, in thy youth; and let thy heart cheer thee in the days of thy youth, and walk in the ways of thine heart, and in the sight of thine eyes: but know thou, that for all these things God will bring thee into judgment. Therefore remove sorrow from thy heart, and put away evil from thy flesh: for childhood and youth are vanity.

16 comments

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comment by gjm · 2018-09-21T17:08:49.994Z · score: 24 (7 votes) · LW · GW

This is a strange article.

The title and opening paragraph suggest that it is comparing Taleb's "barbell" strategy with other investment strategies -- traditional balanced portfolio, gold in a sock under your bed, highly leveraged penny stocks, etc. -- and finding it wanting.

But none of the actual argumentation that follows really makes any contact with that sort of comparison; rather, it applies uniformly across every asset of the sort Taleb, or your financial advisor, or anyone else interested specifically in your investments, might consider. (With one exception; see below.) And its real point seems to be not to argue for or against any particular investment strategy, but to remind us that there are other things that matter more deeply than the accumulation of wealth. I feel as if I have just read an article entitled "Against the King's Gambit" that's devoted to explaining how playing board games like chess is a waste of time. I wonder whether I am missing the point in some spectacular fashion.

Some specifics:

In a scenario where your country's government collapses disastrously, or where you find yourself on the run from deadly persecution, indeed treasury bonds won't help you much; neither will any other sort of financial asset; how you deal with the possibility of such scenarios is largely orthogonal to how you optimize your investments. Seeking spiritual enlightenment or good advice on what food to eat won't be helped much by treasury bonds; nor will they be helped much by any other sort of financial asset; how you manage those aspects of your life is largely orthogonal to how you optimize your investments.

Children and a spouse and belonging to an intergenerational community are (at least for many people) wonderful things, and perhaps (as this article suggests) they provide many of the benefits that we might (perhaps unwisely) look for from our investments. But having decided whether to marry, how many children (if any) to have, etc., the question remains of what to do with whatever wealth one has after all that, and so far as I can see the choice between "barbell", "conventionally diversified investments", "money in a sock under the bed", etc., isn't affected in any very obvious way by whether one has spouse, children, intergenerational community, etc.

(One thing mentioned in the article that is relevant: "land you are used to occupying and know well". To whatever extent that is an Important Good Thing, it suggests that one substantial asset you should own is a land and somewhere to live built on that land. But I don't think that when Taleb proposes a "barbell" strategy he is intending to tell people whether or not to own a house.)

There are indeed no truly risk-free assets, and any asset you hold may become irrelevant. (Incidentally, this applies to houses and spouses and children and intergenerational communities and religions and so forth too: you may suddenly need to move across the country, you and your spouse may cease to make a good couple, your children may turn against you, your community may disapprove of your lifestyle, you may stop believing in your god(s), etc.) But, once again, this has nothing to do with Taleb's "barbell strategy": the risks that would destroy the value of treasury bonds, and the end of your natural life, will uniformly wipe out any other investments you might have, and the question of what to do with any money you choose to invest is once again largely orthogonal to that.

comment by Benquo · 2018-09-23T01:30:41.083Z · score: 2 (1 votes) · LW · GW
And its real point seems to be not to argue for or against any particular investment strategy, but to remind us that there are other things that matter more deeply than the accumulation of wealth. [...] Children and a spouse and belonging to an intergenerational community are (at least for many people) wonderful things, and perhaps (as this article suggests) they provide many of the benefits that we might (perhaps unwisely) look for from our investments.

A definition of "wealth" or "investment" coextensive with financial investment is going to lead to models that extend very poorly if at all to overall life decisions. These get conflated a lot. Most risk is not financial.

But having decided whether to marry, how many children (if any) to have, etc., the question remains of what to do with whatever wealth one has after all that

That first decision - allocating investment of your time between fundamentally different kinds of investment like children, friend networks, and financial savings - is the more important one. It's also one for which the "barbell strategy" is meaningless if taken literally.

comment by gjm · 2018-09-23T15:29:01.744Z · score: 3 (2 votes) · LW · GW

I agree with all that, but this still feels as if I've opened up something called "A refutation of the King's Gambit" and found that it says "Chess is mostly a waste of time. You should probably do something else.". That might be good advice! But it shouldn't be titled "Against the King's Gambit", and it wouldn't be helpful to anyone wanting to decide what opening to play if and when they _do_ play chess.

Taleb's "barbell strategy" is an answer (not necessarily a good one) to the question "What should I do with my financial assets?". Observing that lots of important assets aren't financial, and that there are important decisions that aren't about your finances, has almost nothing to do with that question.

Incidentally, I think "allocating investment of your time between [...] children, friend networks, and financial savings" is a type error. Most people (there are obvious exceptions for hedge fund employees, day traders, etc.) allocate approximately no time to financial savings. Make it "children, friend networks, and paid employment" and it makes more sense.

comment by Benquo · 2018-09-23T17:56:05.114Z · score: 2 (1 votes) · LW · GW
Most people (there are obvious exceptions for hedge fund employees, day traders, etc.) allocate approximately no time to financial savings.

While it's likely true that many people in (at least in the US) live paycheck-to-paycheck, financial investment allocation strategies are even more irrelevant to them than to Taleb's target audience. But for those who work for money and have incomes in excess of expenditures, what are they doing at work, if not allocating time to financial savings?

Neither children, friend networks, nor financial savings are an activity - those are all goods you might acquire and cultivate by means of a mixture of activities.

comment by gjm · 2018-09-23T19:19:48.426Z · score: 2 (1 votes) · LW · GW

What they are doing at work is allocating time to _acquiring money_. They may then save that money (acquiring financial savings) but they may also use it in other ways. They may spend it on their children, or on activities they engage in with their children; that would be an indirect way of allocating time to their children. They may give it away to causes they consider valuable. They may spend it on concert tickets or fancy restaurant meals for the sake of sheer pleasure. Etc.

(Just to be explicit: Having income in excess of expenditure doesn't mean that when you're at work you're allocating time to financial savings, because unless your expenditure is _zero_ -- or, more precisely, less than your income from sources other than paid work -- some of that time at work is supporting your expenditure.)

And, of course, paid employment isn't _exclusively_ about acquiring money. A person may value their personal relations with colleagues (so that going to work is partially a matter of allocating time to their friend networks). They may consider their work valuable in its own right (not implausible; at the very least, it's valuable enough _to someone_ that they get paid for it). They may derive satisfaction from doing difficult things skilfully. And so forth.

comment by Benquo · 2018-09-23T17:51:43.819Z · score: 2 (1 votes) · LW · GW

I think that if someone wrote a series of books about "how to play games," and placed a lot of emphasis on the King's Gambit in a way that implied that it was general advice for game theory rather than advice limited to a very restricted but rightly famous subset of games called chess, and this was the way the King's Gambit had reached popular consciousness, then it would be OK to title a piece explaining the problem "Against the King's Gambit".

But the real reason I used that title here was that I thought that my preferred title (the one I used on my personal blog, "Financial investment is just a symbolic representation of investment projected onto a low-dimensional space inside a control system run by the US government"), would lead to a bunch of annoying and pointless arguments if I used it here on LessWrong, because I expected people to aggressively miss the point. So I replaced a clear description of what I'm arguing for it with a vague pointer to what I'm arguing against, since that seemed more defensible. I think that on the whole this was a good decision.

comment by gjm · 2018-09-24T12:49:10.199Z · score: 4 (2 votes) · LW · GW

I'm not sure I understand your hypothetical scenario. Is our author's message "no matter what you are doing, play the King's Gambit" or "no matter what you are doing, do something analogous to the King's Gambit"?

If the former, then I bet you are fighting a straw man. Does Taleb (or anyone) actually claim that we should ignore everything other than financial investment?

If the latter, then I don't see how your argument actually engages. E.g., Taleb might claim that the things you say we should be doing instead of earning and investing actually fall into one or other of his categories of "as safe as you can manage" and "exposing you to lots of black-swan upside".

My apologies, by the way, if I am (or seem to be) "aggressively missing the point". For the avoidance of doubt, that's not my intention.

comment by Benquo · 2018-09-27T22:17:05.655Z · score: 2 (1 votes) · LW · GW

Doesn't seem like anyone's aggressively missing the point this time, thanks for engaging :)

I'm not sure I understand your hypothetical scenario. Is our author's message "no matter what you are doing, play the King's Gambit" or "no matter what you are doing, do something analogous to the King's Gambit"?

Praise of the king's gambit as a chess opening, mixed with descriptions of generalized strategies for playing adversarial games, in ways that subtly but pervasively imply that it's a central case of game-playing. This is likely to cause readers, on the margin, to notice games where something like the King's Gambit is available and ignore the ones where it's inapplicable.

comment by Douglas_Knight · 2018-09-24T01:12:27.586Z · score: 4 (2 votes) · LW · GW

I think it's fairly common for people who agree with an argument but disagree with its conclusions to title that disagreement "Against X," but I think it would be better to use something like "Taking X Further," or "Beyond X," or, for more hostility, "Taking X Seriously."

comment by Timotheos Patten (timotheos-patten) · 2019-08-29T22:41:29.912Z · score: 3 (2 votes) · LW · GW

You completely misunderstood Taleb's point. In fact, you're arguing in favor of it without even noticing, but more on that at the end.

Your basic misunderstanding is that the barbell strategy is not about finding something that's completely safe; it's about dealing with our inability of estimating the real risk behind things that are presented as medium-risk investments.

With low-volatility assets, we need to use plenty of leverage for the portfolio to move at all. However, if we don't know the real volatility (and we never do, contrary to what portfolio-theory people say), it will result in a blowup. LTCM did exactly this: they over-leveraged their investments based on an incorrect model that suggested it was safe to do so and then they blew up when the market moved just a tiny bit more than their model predicted. Medium-risk investments are not always so, but we never know why, and when it turns out they weren't, it's too late and we go bust.

With risky assets, the above problem doesn't exist: we can use small leverages because we know the occasional large moves will take care of moving the portfolio just enough.

Enter the barbell. I'll stick to financial investments here but the same principle applies everywhere. While treasury bonds are clearly not 100% secure, they are as secure as we can have at the moment, so they will be our "safe" 90% of the portfolio and the remaining 10% will go to truly risky investments. Now, let's imagine a 2-fold change in the value of the risky asset; there's an equal probability for the same move up or down. If it moves down, we lose 5% of our value. If it moves up, we gain 10% of our value: this asymmetry is what the barbell is about.

Obviously, not many things double or half in value overnight, and even what does will do it rarely. So, the barbell strategy depends on as many small risky investments as possible, as the frequency of one of them go up enough would increase. (In Taleb's original case, he sold options that he thought were overpriced and, from the profits, bought options that he thought were underpriced. If the market didn't move, he made some money, if the market moved a bit, he lost some money, if the market moved a lot, he made a fortune.)

"Risky investment" doesn't have to mean "dangerous" by the way. Your example of having a bunch of foreign friends is a perfect example for the barbell strategy: you invest a known and limited amount of your "capital" (a few minutes a week of your time) in exchange for a potential, though not guaranteed, upside of unknown magnitude.


comment by BoilingLeadBath · 2018-09-23T04:27:47.967Z · score: 3 (2 votes) · LW · GW

If the actual utility you receive as a function of the total "payout" of your "investments" has diminishing marginal returns, then the character of the portfolio to maximize expected utility depends upon the failure correlations between the investment options.

IE, in the case that the utility function is sufficiently convex to payout and the various investments all fail independently of each other, a strategy of investing in only the highest yield and lowest risk choices is not optimal: a small investment in a middling investment decreases the risk of total failure (and corresponding hit to expected utility) enough to be worth the hit to expected payout.

I haven't run the analysis, but my intuition is that advocacy for a barbell strategy limited to just high-risk stocks and T-bills is an empirical claim about the risks along the following lines:

1) The failure of middling risk stock is well correlated with the failure of high risk stock

2) The failure of less-risky investments than T-bills (paper currency, rice & beans under nitrogen, solar panels, etc.) are well-correlated with the failure of T-bills and have lower annual yields.

3) Utility is a moderately convex function of payout. (If it were very convex, you'd want most or all of your funds in T-bills, not just a bit; if it were linear or concave, "risk" isn't a thing and all funds would be in the stocks.)

I'll trust Taleb on #1, and #3 seems reasonable most of the time, but on #2, it would seem to me that while a good portfolio would be based around the high-risk stocks backed up with a small portion of cash-equivalents, the "insurance" against failure of both of those things is cheap enough that it should be included early on.

(As an aside, I'm pretty sure that Taleb suggests "mostly" high-yield/high-risk holdings, with only enough T-bill stuff to keep you off the streets if the stock fails. That's not what I'd pick out as a strategy that is likely to cause bad outcomes because you didn't take enough risk.)

comment by ryan_b · 2018-09-23T01:10:26.455Z · score: 2 (1 votes) · LW · GW

I don't see why the insight fails to apply along a continuum. If you do not have access to Treasury-bond equivalents in the risk you are trying to manage, take whatever the stablest option is for most, and then adjust your exposure-to-large-gains appropriately.

Perhaps this would be something like maintain relationships with your diverse friend group as the safe investment, and then do something for fun once a month where you might make friends with a billionaire as the exposure-to-large-upside investment.

comment by Benquo · 2018-09-23T01:38:25.533Z · score: 4 (2 votes) · LW · GW

An example of attending to risk of ruin / integrated risk management across multiple dimensions not captured by the barbell strategy would be a couple with children and little in the way of savings buying life insurance.

comment by ryan_b · 2018-09-27T21:08:31.053Z · score: 4 (2 votes) · LW · GW

It feels like buying life insurance accomplishes the 'minimize exposure to large downsides' objective he discusses. What's the difference, utility-wise, between life insurance that pays out to their spouse/children in the event of their death and a stock that pays off the same amount at the same probability as death?

It seems like these two things should be comparable, but that the life insurance investment is preferable because it mitigates the problem of the children not being provided for (no exposure to large downside) whereas the stock does not (exposure to large upside, still have exposure to large downside).

It occurs to me a lot of these problems effectively stem from the fact that there is a fundamental bias towards large-downside risks; we can be killed or crippled, but there is no symmetric likelihood of living forever or becoming superhuman (for now).

comment by Benquo · 2018-09-27T22:13:05.918Z · score: 4 (2 votes) · LW · GW
It feels like buying life insurance accomplishes the 'minimize exposure to large downsides' objective he discusses.

Yes, but this is an entirely different thing than holding a low-risk asset. It's a high-risk asset that's constructed to be a hedge.

comment by ryan_b · 2018-09-28T15:26:13.756Z · score: 2 (1 votes) · LW · GW

Agreed, but what it accomplishes is helping to make total distribution of risk have the shape he is advocating. When you said 'taken literally' I inferred that to mean we should try and make our total risk distribution look like a lopsided barbell, and it seems like the division between investing in a specific asset class and the multidimensional risk you describe dissolves under that construction.

I would expect that people with enough money to invest in Treasury bonds and startups almost all have life insurance, so they have already taken the same hedging step with the same goal as the low-savings couple. This makes it seem like they might have the same risk strategy, but execution of strategies takes place over time and it just unfolds more slowly because they have less income.

But having articulated it in that way, it occurs to me that there is a very big difference between deploying the barbell strategy in each risk dimension, and deploying the barbell strategy for total risk. That seems to shift the most important task from distinguishing risks within a dimension to comparing risk between dimensions, because investing a lot of thought in managing a dimension with very low risk-mass doesn't affect total risk very much. Further, some dimensions may be all exposure-to-cost and little to no exposure-to-benefit, as with disability/death.

I like the insight that there is also risk affecting the dimension itself, as in the freezing of assets example. Logically there must also be the possibility of new risk dimensions appearing, which a little reflection suggests is obvious at least in the sense of our learning about them even if they were there all along, like germ theory. That makes me wonder about using risk management techniques to detect unknown dimensions.

Edit: I'm not driving at anything in particular here, this is all just a bit stream of consciousness that I wanted to note.