Barbell Strategy
Taleb’s barbell strategy combines a large protected allocation, illustrated as 85-90%, with a small speculative allocation of 10-15%. Its aim is to limit exposure to large losses while retaining a chance of substantial gains; protection depends on the assets and obligations involved.
THE IDEA
I am trying here to generalize to real life the notion of the “barbell” strategy I used as a trader, which is as follows. If you know that you are vulnerable to prediction errors, and if you accept that most “risk measures” are flawed, because of the Black Swan, then your strategy is to be as hyperconservative and hyperaggressive as you can be instead of being mildly aggressive or conservative. Instead of putting your money in “medium risk” investments (how do you know it is medium risk? by listening to tenure-seeking “experts”?), you need to put a portion, say 85 to 90 percent, in extremely safe instruments, like Treasury bills—as safe a class of instruments as you can manage to find on this planet. The remaining 10 to 15 percent you put in extremely speculative bets, as leveraged as possible (like options), preferably venture capital–style portfolios.
That way you do not depend on errors of risk management; no Black Swan can hurt you at all, beyond your “floor,” the nest egg that you have in maximally safe investments. Or, equivalently, you can have a speculative portfolio and insure it (if possible) against losses of more than, say, 15 percent. You are “clipping” your incomputable risk, the one that is harmful to you. Instead of having medium risk, you have high risk on one side and no risk on the other. The average will be medium risk but constitutes a positive exposure to the Black Swan. More technically, this can be called a “convex” combination. Let us see how this can be implemented in all aspects of life.
When to use it
Career planning: Maintain a stable full-time job (safe asset) while dedicating 10-15% of time to entrepreneurial side projects (speculative bet).
Publishing: A publisher focuses on a core stable of classic titles and bestselling authors while also taking risks on a few highly experimental or avant-garde works.
Personal finance: Keep an emergency fund in highly liquid safe instruments and invest a small portion in volatile assets like cryptocurrencies or startup equity.
Business innovation: A company allocates 90% of its R&D budget to incremental improvements in existing products and 10% to radical, high-risk innovations that could disrupt the market.
FROM THEORY TO EVERYDAY LIFE
In practice
Investment Portfolio
An investor puts 90% of capital into Treasury bills and 10% into speculative startup investments. In Taleb’s illustration, the larger allocation provides a reserve while the investor accepts the possibility of losing the speculative portion.
Hedged Speculation
A trader seeks protection designed to limit losses on a speculative portfolio to 15%. Whether the hedge achieves that limit depends on its terms, costs, coverage, and performance under the conditions that produce the loss.
A MOMENT TO REFLECT
Put it to work.
What are the 'safe' assets and 'speculative' bets in your own career or life, and how could you rebalance them to reduce vulnerability to unexpected shocks?
In what areas of decision-making do you currently take moderate risks that could be replaced with a barbell approach of extreme safety and extreme aggressiveness?
How might the barbell strategy change your approach to project management, where you allocate most resources to proven methods and a small fraction to experimental innovations?
Often confused with
CONTINUE THE CONVERSATION
Source texts
- The Black Swan The Impact of the Highly Improbable With a new section On Robustness and Fragility (Nassim Nicholas Taleb)