The Black Swan by Nassim Nicholas Taleb
Nassim Taleb has been known to say that if a book can be summarized it is not worth reading. Nevertheless if I had to summarize this book it would be this: Human nature makes us want to predict and control the future, but for a certain class of real-world problems we are exceedingly bad at it.
Taleb divides the world based on two types of phenomenon, which he calls Mediocristan and Extremistan. In Mediocristan we can use the standard bell curve to predict the distribution. One example: The height of human adults is physically limited – you won’t find a human who is 100 feet tall. So with a reasonable sample you can predict the distribution of human height. But in Extremistan, the distribution is not limited or the limit is so high that it might as well be unlimited. The distribution of wealth falls into Extremistan. If you add Bill Gates to just about any size group, his wealth will dominate the average of the group.
In spite of this, economists and investment advisors almost always use the bell curve and standard deviation to calculate risk. Unfortunately the real investment world does not follow that bell curve. This leads to Black Swan events.
Taleb defines a Black Swan event at follows:
- It is an outlier.
- It carries extreme impact.
- Human nature makes us concoct explanations for its occurrence after the fact.
Note that a highly expected event not happening can also be a Black Swan.
He goes into great detail regarding the many reasons why we have trouble predicting Black Swans, and why we almost always underestimate the risk of a Black Swan. His stories are full of characters from history, philosophy, and human nature. He has little regard for academia and “experts” and enjoys expounding on that.
I have to say this was not an easy read for me and I often found myself wishing he would get to the point in his stories. But I’m glad I stuck with it as there is some real wisdom here, and it could affect how you make investment decisions.