Taleb’s Barbell Strategy
I just completed Antifragile by Nassim Nicholas Taleb, a thought provoking book for sure.
The question I wanted to toss out there is in regards to his barbell strategy. For those who are unaware of the strategy the way he states it in the book, it’s essentially a strategy to cap your downside risk while exposing yourself to the potential of large upside. This is done; he states, by placing 90% of your assets in safe, albeit inflation protected instruments, and the remaining 10% of your portfolio in externally risky assets with large payoffs. In theory he states that this will cap your max loss at 10% and give you exposure to the potential of unlimited upside. This is in contrast to the ‘normal’ portfolio which is, for the sake of example in 70% in stocks and 30% in bonds, deemed to be safe but is vulnerable to ‘Black Swans’ and has no capped downside risk while only achieving small gains.
My thought is while the barbell seems like a fabulous idea at first, it also seems like a difficult strategy to pull off and riddled with assumptions about the 10% in risky assets vastly outperforming. Essentially it seems like a strategy that almost guarantees a 10% loss with a Hail Mary chance of outperforming the standard 70/30 portfolio. Let’s say you are a young investor with $100,000 to invest. So 10% goes into high risk assets with large upside, and you place the remaining in a GIC or some inflation protected product paying 2 - 3% or the like. If we assume that the annual market return for a 10 year period on a 70/30 portfolio is about 5-7% on average, then the 10% portion your barbell portfolio as a whole needs to return around 40%-60% on average to match the return. (I guess you could argue that since the risk exposure is less the payoff should also be less, but let’s assume we want to match or exceed our 70/30)*. But also assuming that in the 10% portion you spread the risk across a few different instruments, and since they are high risk it’s a valid assumption that some of these go to zero (Options) or close to zero. So you will most likely be bleeding out the 10% with the hope of one massive home run from a Black Swan to offset:
1. The money lost in 10% portion
2. Making up the 2.5 - 4.5% given up in the 90% portion of the portfolio.
While I know there are people who are not huge fans of Taleb on here, so if we leave out the ad hominem arguments and just critique the strategy alone, what are your thoughts? What am I missing? Has anyone ever tried this strategy? Anyone see any massive flaws? Anyone huge fans of the strategy? So go for it. Rip it apart or defend it to your death.
*I believe he attacked this mindset of matching the market performance in the book but I cant find the reference.
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