Nassim Nicholas Taleb Angry

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dbr
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Post by dbr » Wed Oct 22, 2008 10:50 am

bobcat2 wrote:Financial economists have not modeled financial returns based on the normal distribution for decades. For example, since the early 1980's they have used ARCH and GARCH models that take fat tails and volatility clustering explicitly into account in modeling return data.

Many financial economists, probably a majority, believe that risky assets, such as stocks, are risky in the LR as well as the SR. You don't have to believe Taleb's far out rants about black swans everywhere to believe that. However, what Taleb then does is to take the perfectly reasonable POV that risky assets are risky in the LR and stretch it toward the absurd in several directions, e.g. nobody knows anything about financial risk except him and Mandlebrot. :roll:

Bob K
As you say, it has never made sense that something as trivial and obvious as financial behavior not being according to normal distributions would be overlooked. It can't really be that Taleb is saying nothing more than that financiers are making that basic a mistake, can it? As posted above Mandelbrot for one apparently thinks even much more sophisticated distributional models are still inadequate.
That is a believable difficulty and also leads to the conclusion pointed out that nobody knows what to do about it.

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Post by linenfort » Wed Oct 22, 2008 10:50 am

I don't know if this has been posted - Taleb was on Newshour yesterday
evening. Scared the life out of me, before I got over it.

http://www.pbs.org/newshour/bb/business ... 10-21.html
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Post by Heath » Wed Oct 22, 2008 10:50 am

Rick Ferri wrote:Taleb's criticism are right on the money, especially his comments on mean variance optimization (MVO) and other models. Past efficient portfolios will not be the future efficient portfolio, and it is foolish to believe that they will be. Monti Carlo Simulation models are not any better. Model's designed for the known physical sciences are ill equipped for the uncertainties of finance.

See Appendix III of my free on-line book, Serious Money, which I wrote 10 years ago.

"In summary, the returns of asset allocation models overstate the return to investors and understate the risks. Many advisors who use the models to sell investment products don’t really understand the statistics behind them, but use them anyway to push products with higher fees."

Rick Ferri
Excellent summary. Why then does this forum continue to point people toward asset allocation techniques such as this, https://personal.vanguard.com/us/planni ... ontent.jsp that understate risks?

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Re: Taleb quote from video

Post by stratton » Wed Oct 22, 2008 10:50 am

speedbump101 wrote:
stratton wrote: Ironically, the hedge fund Taleb is associated with was in Los Angeles up the coast from Diehards VII. There was a chance someone might have been available.

Paul
Taleb at a Diehards? That would truly be a black swan event... Re the LA office of Universa... it's in Santa Monica, a five minute walk from DFA's headquarters... :-)
I'd say the chances of Taleb would have been about zero. The other two or three principles of the fund would probably have been able to give just as good a talk.

Agree with you getting Taleb himself would have been a positive black swan for us. I have no idea what kind of "hook" Mr. Bogle would have been at attracting him.

Paul

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Post by bobcat2 » Wed Oct 22, 2008 10:51 am

Hi Rick,
You wrote the following.
Talib (sic) is right!
Then you must concur with the following.
What Taleb is saying is that relatively risky financial assets such as US stocks, foreign stocks, REITS, corporate bonds, and LT Treasuries are much riskier than the mean/variance approach of trading off higher return against higher risk, which is the Boglehead approach, implies.
...
Thus it is a fool's errand in Taleb's opinion to invest at all in US and foreign stocks and other relatively risky financial assets. In other words your AA of stocks, REITS, and anything but ST AAA rated fixed income and derivatives should be zero. In Taleb's world view long-term financial disaster is nearly guaranteed for those who invest in diversified portfolios of risky assets because the risk of total meltdown is so much greater than commonly believed.
Do you :?:

Bob K
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Post by peter71 » Wed Oct 22, 2008 10:53 am

Heath wrote:I can excuse Taleb's arrogance and give him credit for forcefully stating why the economists continue to get it wrong (because they continue to ignore the points that he/Mandelbrot are making).

Mandelbrot also seems to believe that "there has GOT to be a better way", but he concedes that he can't figure it out.

What is wrong with the approaches most often used on this forum is that they ignore the fat tails because there is not a formula for dealing with them. People who do not build in these fat tails when setting their allocations, i.e., accept and allow for an additional level of risk, are taking on more risk than they can handle.
If you want to examine HISTORICAL fat tails you can pretty easily get data on "skewness" and "kurtosis," and conceivably you could also build these variables into a monte carlo simulation (though it's easier to just not rely too much on monte carlo simulations).

If you want to allocate some of your money to bets on PROSPECTIVE fat tails, you can buy out of the money options.

On the other hand, no one, including Taleb himself, really has any way to bet on "unknown unknowns," so insofar as he's using his black swan stuff to market his fat tails stuff I think it's quite understandable that people are getting confused . . .

All best,
Pete

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Post by Joshv02 » Wed Oct 22, 2008 10:54 am

Taleb nodded towards owning a broad, diversified and indexed portfolio during a podcast of EconTalk with Russ Roberts. He said doing so would lessen, though not get rid of, the 1/n problem. I don't think Taleb ever says we should remove risk - only that that we should recognize it and its instability.

More to the point, the issue is one of modeling and the limitation of knowledge. Even if power laws explain finance risk better than the alternatives, Taleb was careful - if I recall correctly - to not claim that the exponent is in anyway stable. In other words, say you figured out how to model yesterday - that does not imply that the same model will explain tomorrow or that a model for tomorrow can ever exist with the level of certainty that people state . . . until tomorrow is yesterday.

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Post by Heath » Wed Oct 22, 2008 11:06 am

Of course there is no specific way to deal with prospective fat tails. About all that can be done is to factor into asset allocations the increased risk from the fat tails (as Mandelbrot suggests). The fact that there is no formula available to deal with this risk is not a reason to simply ignore the risk as much asset allocation planning seems to do.

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Post by Lbill » Wed Oct 22, 2008 11:08 am

As one simple (minded) takeaway, what would be wrong with the idea of a "hybrid" portfolio approach. I have a core of diversified asset holdings and also purchase "fat-tail" insurance in the form of out-of-the-money puts? Or maybe it just makes the most sense to mimic Taleb and hold TIPS and use the interest to bet on the fat tails. Worst I could do is end up with the same real principal I started with, but I'd probably do better since I could harvest the fat tails along the way.
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Re: Taleb quote from video

Post by VictoriaF » Wed Oct 22, 2008 11:16 am

stratton wrote: He has one heck of a speaking fee from this article:
Taleb's fee for a speaking engagement: "about $60,000"
I have no idea how much of "hook" Jack Bogle might be. :wink:

Paul
We can try Dan Ariely's coherent arbitrariness on him. Quoting from "Predictably Irrational" Chapter 2, "The fallacy of supply and demand"
From our perspective, Tom [Sawyer] transformed a negative experience to a positive one - he transformed a situation in which compensation was required to one in which people (Tom's friends) would pay to get in on fun.
Like Tom Sawyer, Dan Ariely made a half of his students pay for his poetry readings, while the other half was paid for the exposure to this supposedly painful experience.

And so if we tell Taleb that there is an extra charge for attending DH reunions by hedge fund managers, celebrities, eccentrics, or something like that - Taleb will absolutely have to be there :twisted:

And did not Taleb say that one should always go to parties seeking the exposure to positive Black Swans?

Victoria

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Re: Taleb quote from video

Post by stratton » Wed Oct 22, 2008 11:23 am

VictoriaF wrote:
stratton wrote: He has one heck of a speaking fee from this article:
Taleb's fee for a speaking engagement: "about $60,000"
I have no idea how much of "hook" Jack Bogle might be. :wink:

Paul
We can try Dan Ariely's coherent arbitrariness on him. Quoting from "Predictably Irrational" Chapter 2, "The fallacy of supply and demand"
From our perspective, Tom [Sawyer] transformed a negative experience to a positive one - he transformed a situation in which compensation was required to one in which people (Tom's friends) would pay to get in on fun.
Like Tom Sawyer, Dan Ariely made a half of his students pay for his poetry readings, while the other half was paid for the exposure to this supposedly painful experience.

And so if we tell Taleb that there is an extra charge for attending DH reunions by hedge fund managers, celebrities, eccentrics, or something like that - Taleb will absolutely have to be there :twisted:

And did not Taleb say that one should always go to parties seeking the exposure to positive Black Swans?
Ok, VictoriaF writes the invitation!

Paul

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Post by Rick Ferri » Wed Oct 22, 2008 11:25 am

bobcat2,

Asset Allocation models generate a standard measure of risk that does not take into consideration uncertainly. The models give you some way of thinking about the problem you're tackling, but they don't necessarily give you the answer. Users of those models must be aware of the uncertainties that can and do occur (black swans) and build in extra risk avoidance measures in anticipation of the unanticipated.

Lets put this in perspective. Assume you take a risk tolerance questionnaire. The computer determines that you have a maximum risk level of 70% in equities based on your answers. You should not go more than 60% in equity because the model is likely flawed and your true tolerance for risk is actually lower because the model used cannot reflect portfolios uncertainties that arise from unexpected actions in the markets.

Here is another example. All of the research reports on commodities that covered this discussion board inferred that an allocation to collateralized commodities futures funds (CCFs) decreased portfolio risk when equity risk increased. The problem there was the interpretation of the data. People only wanted to look at broad correlations rather than day-to-day data. Now we see that commodities can increase portfolio risk during economic downturns.

Again, models give you some way of thinking about a problem, but they don't necessarily give you the answer. And in many cases the problem is not the models, it is the interpretation and understanding of the them.

Rick Ferri
Last edited by Rick Ferri on Wed Oct 22, 2008 11:30 am, edited 2 times in total.

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Taleb on investing in the stock market

Post by bobcat2 » Wed Oct 22, 2008 11:29 am

From the London Times in June of this year.
And you and me? Well, the good investment strategy is to put 90% of your money in the safest possible government securities and the remaining 10% in a large number of high-risk ventures. This insulates you from bad black swans and exposes you to the possibility of good ones. Your smallest investment could go “convex” – explode – and make you rich. High-tech companies are the best. The downside risk is low if you get in at the start and the upside very high. Banks are the worst – all the risk is downside. Don’t be tempted to play the stock market – “If people knew the risks they’d never invest.”
Does this advice from Taleb sound even remotely like the advice Queen Laura of the Bogleheads would give :?: Of course not! Taleb portfolio advice and Boglehead portfolio advice aren't miles apart, instead they inhabit separate universes.

Link to London Times article.
http://business.timesonline.co.uk/tol/b ... =36&page=4

Bob K
Last edited by bobcat2 on Wed Oct 22, 2008 12:19 pm, edited 1 time in total.
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Re: Taleb on investing in the stock market

Post by Rick Ferri » Wed Oct 22, 2008 11:33 am

bobcat2 wrote:From the London Times in June of this year.
And you and me? Well, the good investment strategy is to put 90% of your money in the safest possible government securities and the remaining 10% in a large number of high-risk ventures. This insulates you from bad black swans and exposes you to the possibility of good ones. Your smallest investment could go “convex” – explode – and make you rich. High-tech companies are the best. The downside risk is low if you get in at the start and the upside very high. Banks are the worst – all the risk is downside. Don’t be tempted to play the stock market – “If people knew the risks they’d never invest.”
Don't tell that to people who invested in German government bonds prior to WW I. Also, on an after-tax, after inflation basis, the safest possible government securities may not be safe after all. BTW, isn't that what the Social Security Trust Fund is invested in?

Rick Ferri

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Post by stratton » Wed Oct 22, 2008 11:38 am

Rick Ferri wrote:Again, models give you some way of thinking about a problem, but they don't necessarily give you the answer. And in many cases the problem is not the models, it is the interpretation and understanding of the them.
Dorsey's Active Alpha book in a discussion on this topic mentions the common one they see is EM bonds come up for large allocations. Gibson's Asset Allocation has the TIAA RE Account come up big in MVO testing. Another book by Evensky & Katz has bank loan funds coming up big for lower volatility asset allocation and using 50% of them as an example (ughh!). In the last case the person writing the chapter doesn't apppear to be examining his MVO output.

Computer optimized asset allocation can be dangerous without supervision.

Paul

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Post by bobcat2 » Wed Oct 22, 2008 11:39 am

Hi again Rick,

Do you agree with Taleb that investors should invest 90% of their portfolio in very safe assets (such as ST Treasuries) and either 10% in way out of the money calls and puts or 10% in high risk individual small company stocks. That's what Taleb believes investors should do. You said Taleb was right. So do you believe that's the right way for nearly all investors to allocate their financial portfolios?

This isn't a trick question. Either you agree with Taleb's portfolio allocation advice or you don't.

Perhaps you would like to amend your earlier post to "Taleb is wrong!" :lol:

Bob K
Last edited by bobcat2 on Wed Oct 22, 2008 11:51 am, edited 1 time in total.
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Post by Rick Ferri » Wed Oct 22, 2008 11:51 am

bobcat2 wrote:Do you agree with Taleb that investors should invest 90% of their portfolio in very safe assets (such as ST Treasuries) and either 10% in way out of the money calls and puts or 10% in high risk individual small company stocks. That's what Taleb believes investors should do. You said Taleb was right. So do you believe that's the right way for nearly all investors to allocate their financial portfolios?

This isn't a trick question. Either you agree with Taleb's portfolio allocation advice or you don't. :lol:
Bob K
I agree with him about the limitation of using models in making investment decisions, not how long-term investors should allocate assets. The bottom-line is that investing is risky. If you want to make a return higher than inflation after tax, you need to have faith that the world economy is not coming to an end. And if it does come to an end, well, you might want to hedge that risk by planting a garden buying a rifle!

:wink:

Rick Ferri

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Financial Hell from Taleb's POV

Post by bobcat2 » Wed Oct 22, 2008 12:14 pm

Rick Ferri's method of portfolio construction is based implicitly on a mean/variance approach where riskier assets with higher expected returns are traded off against safer assets with lower expected returns. Taleb not only rejects formal reliance on efficient frontier type models to construct portfolios but, in addition, he also rejects the framework of informal portfolio construction advocated by Rick and other Bogleheads. Taleb sees little distinction between these two sinful methods of portfolio construction and sees both as paths to financial hell. :D

Bob K
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Post by Rodc » Wed Oct 22, 2008 12:59 pm

Lbill wrote:Prokofiev- What I like about Taleb's approach is that when the "whacking" is going on (as it is now) I would be making lots of money while the blood is running in the streets. I think I'd be willing to not make money 90% of the rest of the time for that. Much better for me psychologically than watching my port shed 50% in the belief that it'll be OK in the long run. Over the last decade, our poor stock investor had to wait 9 years to break even on his stocks, just in time to get whacked again. Not my cuppa tea, I'm afraid. :shock:
Bold added. Unfortunately no one is promising you that you'll make money 10% of the time and not 90% of the time. The whole point is risk is risk, nothing is guaranteed. This may never pay off.

Fine if you have enough in safe investments to live off.

Provided of course someone has a risk model sufficiently accurate to make sure your "safe" assets are safe...

If one really believes firmly in Taleb's message there is no hope. After all it is the unknown unknown that is going to rise up and bite you. If you can plan for it, "it" ain't the unknown unknown that is going to bring you down.

Added: as to the difficulty of watching your portfolio drop 50% (not likely if you have reasonable amount in safe treasuries etc, but let's not worry about that right now), how would you feel watching your portfolio dwindle to 50% due to the ravages of inflation and drawdowns as you you wait for that once in 20 years, maybe once in 30 years, maybe never in your remaining life-time black swan to save you?

No way out and no where to hide.
Last edited by Rodc on Wed Oct 22, 2008 1:07 pm, edited 1 time in total.
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Re: Financial Hell from Taleb's POV

Post by SkepticalGuy » Wed Oct 22, 2008 1:01 pm

bobcat2 wrote:Rick Ferri's method of portfolio construction is based implicitly on a mean/variance approach where riskier assets with higher expected returns are traded off against safer assets with lower expected returns. Taleb not only rejects formal reliance on efficient frontier type models to construct portfolios but, in addition, he also rejects the framework of informal portfolio construction advocated by Rick and other Bogleheads. Taleb sees little distinction between these two sinful methods of portfolio construction and sees both as paths to financial hell. :D

Bob K
As far as I've been able to figure, he may well be right.

That's why these discussions always end up in an angry or (at best) inconclusive state. I seldom hear anyone attack Taleb on the fundamentals of what he says about risk. We all like to say "How interesting" or "Nothing new there--I knew it all along". But when it comes to facing the practical implication--that our beloved portfolios are houses of cards in a probable financial storm--we mutter grimly about buying seeds and weapons and then go back to using the same old strategies.

I think if there were some more palatable alternatives than simply being rich enough to ride it out a meltdown in cash and Treasuries the discussions would be a lot more interesting and might progress beyond the seemingly inevitable guns and gardens conclusion...

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Re: Financial Hell from Taleb's POV

Post by Heath » Wed Oct 22, 2008 1:13 pm

SkepticalGuy wrote:
bobcat2 wrote:Rick Ferri's method of portfolio construction is based implicitly on a mean/variance approach where riskier assets with higher expected returns are traded off against safer assets with lower expected returns. Taleb not only rejects formal reliance on efficient frontier type models to construct portfolios but, in addition, he also rejects the framework of informal portfolio construction advocated by Rick and other Bogleheads. Taleb sees little distinction between these two sinful methods of portfolio construction and sees both as paths to financial hell. :D

Bob K
As far as I've been able to figure, he may well be right.

That's why these discussions always end up in an angry or (at best) inconclusive state. I seldom hear anyone attack Taleb on the fundamentals of what he says about risk. We all like to say "How interesting" or "Nothing new there--I knew it all along". But when it comes to facing the practical implication--that our beloved portfolios are houses of cards in a probable financial storm--we mutter grimly about buying seeds and weapons and then go back to using the same old strategies.

I think if there were some more palatable alternatives than simply being rich enough to ride it out a meltdown in cash and Treasuries the discussions would be a lot more interesting and might progress beyond the seemingly inevitable guns and gardens conclusion...
I think that there are palatable alternatives; unfortunately the palatable alternatives do not convert to formulas for everyone to use. Instead they require thinking realistically about one’s personal situation, and accepting the fact that there is no one that can give you the answers.

When people set their allocations do they really consider a worst case scenario (such as that being discussed today), or do they instead assume that the Trinity Study will solve all problems in the long term. Do people plan allocations based upon the “sleep test” or do they consider the real risks and what those risks might mean to their financial future? A realistic evaluation of risk in the context of the individual circumstances is the palatable alternative and there never will be a simple formula to follow.

It’s true that no one can measure the unknown unknowns, but everyone can understand that they are potentially very bad and factor them into their overall planning.

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Post by SkepticalGuy » Wed Oct 22, 2008 1:15 pm

Rodc wrote:
If one really believes firmly in Taleb's message there is no hope. After all it is the unknown unknown that is going to rise up and bite you. If you can plan for it, "it" ain't the unknown unknown that is going to bring you down.
Rod, your post showed up as I was writing mine--wish I had seen yours first.

Grim as Taleb's message may be, I wonder if we're wimping out too early when we conclude that there's no hope. I don't recall that he ever said all statistical methods are bad and all assets are always hopelessly risky. He makes some more specific criticisms of how we analyze risks. I'm sure he'd admit that a meteor might wipe out all life tomorrow, but I don't think that's his focus.

We might be a little like the guy who says he might as well keep smoking because if the smoke doesn't kill him something else will. What he says is true as far it goes, but it ignores the possibility that he might live a little longer if he quit. Maybe we're ignoring the benefits of some other options, too. Wish I could tell you what they are... :D

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Post by Rodc » Wed Oct 22, 2008 1:26 pm

SkepticalGuy wrote:Rodc wrote:
If one really believes firmly in Taleb's message there is no hope. After all it is the unknown unknown that is going to rise up and bite you. If you can plan for it, "it" ain't the unknown unknown that is going to bring you down.
Rod, your post showed up as I was writing mine--wish I had seen yours first.

Grim as Taleb's message may be, I wonder if we're wimping out too early when we conclude that there's no hope. I don't recall that he ever said all statistical methods are bad and all assets are always hopelessly risky. He makes some more specific criticisms of how we analyze risks. I'm sure he'd admit that a meteor might wipe out all life tomorrow, but I don't think that's his focus.

We might be a little like the guy who says he might as well keep smoking because if the smoke doesn't kill him something else will. What he says is true as far it goes, but it ignores the possibility that he might live a little longer if he quit. Maybe we're ignoring the benefits of some other options, too. Wish I could tell you what they are... :D
Larry approach has it's merits, but I have not yet drank that version of the cool-aid. :)

One of the difficulties for the Little Guy is the part where you buy lots of risky investments with 10% of your money. Takes a lot of money to be able to split it up into many risky bets. And the Little Guy has limited ability to invest in risky stuff that is not simply a rip-off anyway.

So it seems to me to come down to unless you are rich you take risk whether you want to or not. I don't mean that to sound overly fatalistic. I take on mortal risk every day when I get in my car and drive to work, but I don't let that stop me.
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Post by Kenkat » Wed Oct 22, 2008 1:35 pm

Rodc wrote:Added: as to the difficulty of watching your portfolio drop 50% (not likely if you have reasonable amount in safe treasuries etc, but let's not worry about that right now), how would you feel watching your portfolio dwindle to 50% due to the ravages of inflation and drawdowns as you you wait for that once in 20 years, maybe once in 30 years, maybe never in your remaining life-time black swan to save you?

No way out and no where to hide.
I think you nailed it right here.

To me, Taleb is just playing a different version of the same game. We buy and hold investors expect to take hits but eventually have the markets come back to the point we are ok. Taleb expects the market to take big hits and profit from it. As you said, there are certainly no guarantees the market will take bit hits at the right time and/or you will be properly positioned to profit from it. Taleb's black swan is that the hit never comes or doesn't come as he expects it. His strategy is risky too - he just hopes he gets to say "I told you so" every 20 or 30 years.

It reminds me of the people who dress in all black (my son calls them Emos or Goths) who think of themselves as non-conformists and look down on all of us "conformists". No, you are just conforming to a different conformity.

Best regards,
Ken

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Post by nisiprius » Wed Oct 22, 2008 1:53 pm

Rodc wrote:Fine if you have enough in safe investments to live off....

...as to the difficulty of watching your portfolio drop 50% (not likely if you have reasonable amount in safe treasuries etc, but let's not worry about that right now), how would you feel watching your portfolio dwindle to 50% due to the ravages of inflation and drawdowns as you you wait for that once in 20 years, maybe once in 30 years, maybe never in your remaining life-time black swan to save you?
Look, TIPS exist. There are conservative investments that are not subject to the ravages of inflation.

Speaking as the proud owner of an AIG-underwritten income annuity, I am well aware of the possibility of insurer risk (which can be managed). An inflation-indexed SPIA at age 65 pays out considerably more than the traditional 4%-than-COLAed "safe withdrawal rate." E.g. for a joint CPI-indexed annuity for a couple both aged 65, over 5.5% the first year and COLAed subsequent years.

If you can live on a 4%-than-COLAed withdrawal rate, you can live on such an annuity.

In fact, if you can live on 4%-then-COLAed, you can use 72% of your assets to buy the annuity--72% * 5.5 = 4--and invest the remaining 28% in anything you like, use it as a reserve, leave it your kids. You can even put 10% into "positive black swan" long shots and have 18% left as a reserve.

The "what about the risk of conservative investments" meme is misleading.
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Post by dumbmoney » Wed Oct 22, 2008 2:03 pm

stratton wrote:
bookshot wrote:How do you tell institutions, for example, to not use discredited financial models?
This is what I like about Vanguard. They've avoided a large part of the problems by not buying the "complicated" stuff. No CDOs etc. No subprime ultra-short bonds in the TIPS fund.
Well, they now have a Market Neutral fund, and the Managed Payout funds are very un-Bogle-ish.

And they have money market funds, which are part of the current financial panic (although Vanguard has managed them better than others).

But you can ignore that crap and just buy the pure stuff (index funds and treasury bond funds).
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Post by Rodc » Wed Oct 22, 2008 2:14 pm

nisiprius wrote:
Rodc wrote:Fine if you have enough in safe investments to live off....

...as to the difficulty of watching your portfolio drop 50% (not likely if you have reasonable amount in safe treasuries etc, but let's not worry about that right now), how would you feel watching your portfolio dwindle to 50% due to the ravages of inflation and drawdowns as you you wait for that once in 20 years, maybe once in 30 years, maybe never in your remaining life-time black swan to save you?
Look, TIPS exist. There are conservative investments that are not subject to the ravages of inflation.

Speaking as the proud owner of an AIG-underwritten income annuity, I am well aware of the possibility of insurer risk (which can be managed). An inflation-indexed SPIA at age 65 pays out considerably more than the traditional 4%-than-COLAed "safe withdrawal rate." E.g. for a joint CPI-indexed annuity for a couple both aged 65, over 5.5% the first year and COLAed subsequent years.

If you can live on a 4%-than-COLAed withdrawal rate, you can live on such an annuity.

In fact, if you can live on 4%-then-COLAed, you can use 72% of your assets to buy the annuity--72% * 5.5 = 4--and invest the remaining 28% in anything you like, use it as a reserve, leave it your kids. You can even put 10% into "positive black swan" long shots and have 18% left as a reserve.

The "what about the risk of conservative investments" meme is misleading.
Hi nisiprius,

It was not my intention to discuss the "what about the risk of conservative investments" meme. :)

I was intending to address one particular post that did not include annuities, and seemed to me to directly compare only two approaches, traditional buy and hold and Taleb's black swan approach, and moreover for someone who needed additional growth.

It was not my intention to imply those were the only two approaches. Yes TIPS exist and once you have enough money they are great at eliminating or greatly reducing inflation risk, actually very useful even if you don't have enough to do the whole trick. If you have enough to live on that helps a great deal, in fact it would seem one is done at that point.

If you don't have quite enough to use TIPS to live on, an annuity would seem to be a great deal. Maybe even a great deal if you do. The fact that one can get an annuity at better than 4% with a cola rider is very helpful. That means some people can get out of investing in the normal sense altogether, neither in the buy and hold camp or in the Taleb camp. But that did not seem to be part of the post I intended to address. In my opinion annuities are a very important issue though. The more I learn about investing the more appealing I find annuities.
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Post by jdmetz » Wed Oct 22, 2008 2:27 pm

bobcat2 wrote:Do you agree with Taleb that investors should invest 90% of their portfolio in very safe assets (such as ST Treasuries) and either 10% in way out of the money calls and puts or 10% in high risk individual small company stocks. That's what Taleb believes investors should do. You said Taleb was right. So do you believe that's the right way for nearly all investors to allocate their financial portfolios?
I think there is a middle ground here. I agree with Taleb that quantitative risk managers at investment banks should do more intelligent risk modeling than just mean and variance when they are dealing with 40x leveraged investments. In fact, maybe they shouldn't deal with such leverage at all due to unknown risks. I disagree with him that the average person should invest 90% in treasuries and 10% in high variance stock, as this won't provide a high enough return for the average person.

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Re: Taleb

Post by Trestles » Wed Oct 22, 2008 2:29 pm

bobcat2 wrote:In Taleb's world view long-term financial disaster is nearly guaranteed for those who invest in diversified portfolios of risky assets because the risk of total meltdown is so much greater than commonly believed.
In that case I have an investment that will far outperform Taleb's approach: A bomb shelter supplied with my life expectancy of canned goods and water, a toilet, a shotgun and a library of books to read.

This investment strategy will work well for nuclear war, asteroids, complete societal breakdowns and even zombie outbreaks. It will even work for any combination of the above. Talk about diversification! If the world goes crazy Mad Max style I won't look to my retirement portfolio for a solution.

Assuming the world doesn't go crazy I expect my index funds to do quite well -- even if we hit several bear markets, recessions and depressions along the way.

I'm not disagreeing with anything you said bobcat2. I'm just trying to point out that investing money assumes the world will be relatively stable during our lives. If we are worried about catastrophic scenarios then we should expand our tool belt beyond investing.

Trestles

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Post by jhd » Wed Oct 22, 2008 2:41 pm

I think Taleb is spot on in some of his thoughts on market psychology, risk, Wall Street, etc. And I find his investment ideas intriguing.

At the same time, when I read his writings, I get the sense that anyone who invests in stocks will eventually go bankrupt. Maybe today, maybe in 20 years, but someday.

In reality, people who have invested regularly in a simple portfolio (like Taylor's 4 fund portfolio) have done just fine over the long run. That may not hold true in the future, of course. But there are fundamental reasons to think that it will, as long as you're willing to ride out big storms, and you invest new money regularly.

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Post by jdmetz » Wed Oct 22, 2008 2:50 pm

jhd wrote:I think Taleb is spot on in some of his thoughts on market psychology, risk, Wall Street, etc. And I find his investment ideas intriguing.

At the same time, when I read his writings, I get the sense that anyone who invests in stocks will eventually go bankrupt. Maybe today, maybe in 20 years, but someday.

In reality, people who have invested regularly in a simple portfolio (like Taylor's 4 fund portfolio) have done just fine over the long run. That may not hold true in the future, of course. But there are fundamental reasons to think that it will, as long as you're willing to ride out big storms, and you invest new money regularly.
I think he has a much bigger issue with people using leverage to invest in stocks. If you have a well diversified portfolio, through index funds or other means and you go bankrupt it most likely means that the world is in pretty bad shape. If you are leveraged 4 to 1, though, because your models told you that your diversifying have significantly reduced the risk, your run the risk of a black swan bankrupting you.

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Post by Lbill » Wed Oct 22, 2008 2:52 pm

As we speak, DOW is off by 7.3% today (10/22). This will qualify as the one of the 10 worst daily losses, and along with the other two this month will make 3 of the worst 10 in market history. Taleb is making tons of money on this while we all talk politely about portfolio rebalancing.... :cry:
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Re: Financial Hell from Taleb's POV

Post by Rick Ferri » Wed Oct 22, 2008 2:53 pm

bobcat2 wrote:Rick Ferri's method of portfolio construction is based implicitly on a mean/variance approach where riskier assets with higher expected returns are traded off against safer assets with lower expected returns.
No, no, no, no no, Bob. Don't try to spin this. Your statement is not correct and I can prove it. In my All About Asset Allocation book, I discuss the theoretical aspects of MVO models and ALSO discuss at length the limitations with using that model in a live portfolio. I spend much time showing that theory and practice are often at odds. In addition, I have travelled all over the country to various financial planners events held by the FPA and NAPFA to present a lecture titled "Asset Allocation - When Theory and Practice Collide". That lecture is all about why advisors should not rely solely on MPT theory when building portfolios. MVO is a model that is fine to consider as a framework for portfolio construction, but common sense is also important.

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Post by bobcat2 » Wed Oct 22, 2008 2:57 pm

Hi Trestles,
Let me be clear about my position since you have apparently misunderstood it. IMO Taleb is a crackpot and if nobody listened to him the world would be a better place. IMO the advice of Jim Cramer and Taleb is quite different, but both give very bad investment advice.

Having said that it remains true IMO that many people seriously under estimate the LR risk of investing in equities. However, you certainly do not have to follow Taleb's analysis of financial markets or his portfolio solutions to arrive at that conclusion.

Following the financial advice of well known economists including Nobel laureates such as Merton, Samuelson, and Sharpe as well as other well known economists such as Diamond, Bodie, and Kotlikoff would all lead to the advice of invest prudently but be aware that there is the possibility, but not a probability, that LR stock returns could be negative in real terms over several decades.

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Re: Taleb

Post by dumbmoney » Wed Oct 22, 2008 3:05 pm

Trestles wrote:
bobcat2 wrote:In Taleb's world view long-term financial disaster is nearly guaranteed for those who invest in diversified portfolios of risky assets because the risk of total meltdown is so much greater than commonly believed.
In that case I have an investment that will far outperform Taleb's approach: A bomb shelter supplied with my life expectancy of canned goods and water, a toilet, a shotgun and a library of books to read.

This investment strategy will work well for nuclear war, asteroids, complete societal breakdowns and even zombie outbreaks. It will even work for any combination of the above. Talk about diversification!
To be picky, that's more of a hedging strategy than a diversification strategy.

The most conservative portfolio I've seen discussed on this forum is the Harry Browne portfolio, which has 25% in gold (preferably coins). Gold can survive a variety of "unknown unknowns".
I am pleased to report that the invisible forces of destruction have been unmasked, marking a turning point chapter when the fraudulent and speculative winds are cast into the inferno of extinction.

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Post by swyck » Wed Oct 22, 2008 3:08 pm

matt wrote:VictoriaF wrote:
In Black Swan Taleb mentions his discussions with the military people as very rewarding. He says that they understand uncertainty and risk more than anybody else, and he refers to "unknown unknowns."
Malcolm Gladwell's Blink discusses a Pentagon war game that implies the military only talks a good game, but really doesn't know what it doesn't know.
But they know that, which I think was the point. :D

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Post by bobcat2 » Wed Oct 22, 2008 3:16 pm

Hi Rick,

I am certainly not saying that you use only MVO analysis. But certainly when you construct portfolios you consider risk vs reward when deciding how to put the portfolios together. If you were not trading off risk and reward wouldn't you put everything in EM's so you could get the highest ER?

I don't see that much wrong with what you are doing, and I think an advisor would be foolish to mechanically follow a MVO model.

My point is that Taleb doesn't care. In his world view there is not a dime's worth of difference between following MVO analysis closely vs. doing asset class portfolio construction relying heavily on common sense instead of models, such as how I assume you construct portfolios.

I don't agree with Taleb, but it is important to understand what he is saying. Taleb is not impressed by MVO models and there is no reason apriori to believe he would be any more impressed by your approach to portfolio construction. Taleb believes constructing portfolios by diversifying across asset classes is horse pucky, however it is done.

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Post by jhd » Wed Oct 22, 2008 3:16 pm

jdmetz wrote:I think he has a much bigger issue with people using leverage to invest in stocks. If you have a well diversified portfolio, through index funds or other means and you go bankrupt it most likely means that the world is in pretty bad shape. If you are leveraged 4 to 1, though, because your models told you that your diversifying have significantly reduced the risk, your run the risk of a black swan bankrupting you.
I think you're right. But I think he - or his followers/critics/commentators - sometimes blurs the line between equity indexers and highly leveraged hedge fund managers.
Lbill wrote:As we speak, DOW is off by 7.3% today (10/22). This will qualify as the one of the 10 worst daily losses, and along with the other two this month will make 3 of the worst 10 in market history. Taleb is making tons of money on this while we all talk politely about portfolio rebalancing....
Of course, today's results only matter if you need your money today. Which approach will do better over the next 10, 30, 50 years? For most of us, that's what matters. And those who move out of the market when the market is down, and into the market when it starts booming, will do worse than either Taleb or Bogle.

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Re: Financial Hell from Taleb's POV

Post by HerbertSitz » Wed Oct 22, 2008 3:22 pm

Rick Ferri wrote:
bobcat2 wrote:Rick Ferri's method of portfolio construction is based implicitly on a mean/variance approach where riskier assets with higher expected returns are traded off against safer assets with lower expected returns.
No, no, no, no no, Bob. Don't try to spin this. Your statement is not correct and I can prove it. . . .
Rick -- IMO Bob K. isn't spinning anything. Your managment may involve a common sense application of modern portfolio theory, but it implicity or explicity acknowledges the idea that expected risk is tied to expected reward, the layering of risk premia as we go up in spectrum from least risk assets to most risky assets, etc.

Frankly, I think that method of management (i.e, your method) is a very good thing, and I don't understand why you seem to want throw your hat fully in the ring with Taleb. Taleb would _never_ approve of having a client portfolio invested 80% in stocks. Taleb would _never_ approve of a TSM/TBM allocation. Yes, you may be in minor agreement with him regarding a thing or two, but his is basically a radical position that's far, far outside the mainstream of acceptable portfolio management.

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Post by Lbill » Wed Oct 22, 2008 3:23 pm

I don't think Taleb thinks that diversifying across asset classes is horse pucky. He thinks that there is are "risky" and a "non-risky" asset classes and that you should diversify between these - anything more than that is horse pucky. Not that different from Bogle is it? :D
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Post by HerbertSitz » Wed Oct 22, 2008 3:40 pm

Lbill wrote:I don't think Taleb thinks that diversifying across asset classes is horse pucky. He thinks that there is are "risky" and a "non-risky" asset classes and that you should diversify between these - anything more than that is horse pucky. Not that different from Bogle is it? :D
Very different from Bogle. Read London Times article bobcat quoted above (
http://business.timesonline.co....amp;page=4 ) or read one of Taleb's books.

Bogle diversification is to "hold the market", that is, hold all securities in same proportion as they constitute of overall market.

Taleb isn't really about diversification at all. His method of investing: invest vast majority of your assets so that they won't lose much money; invest tiny portion in the riskiest investments you can find, those with highest upside. This method guarantees that you won't lose much. At the same time, because the likelihood of a "positive black swan" is supposedly underweighted in prices of highly risk securities, you stand to make a good gain. Interesting idea, but I've never seen any real-world proof that's it's preferable to Boglehead strategy of holding TSM/TBM, or even that it's as good as a Boglehead's holding the market.

Others have said Larry S. is basically a follower of Taleb. I would agree that from what I know Larry's personal investment philosophy leans a little bit that way, but I'm pretty sure even it falls far short of anything Taleb would approve.
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Post by bobcat2 » Wed Oct 22, 2008 3:41 pm

Anybody who thinks the strategy of having everyone invest solely in ST Treasuries and far out of the money options is the same thing as Jack Bogle's investment advice is well beyond my modest powers of persuasion. :lol:

I noticed that recently Jack Bogle and Zvi Bodie did a joint investment strategy interview for Business Week.

I cannot imagine either of those gentlemen sitting down for a joint interview with Taleb. If either of them was foolish enough to do that, I assume that after several minutes of insults either Jack or Zvi would have the good sense to bid a less than fond adieu to Mr Taleb, which is what Ken Rogoff should have done in the BBC discussion that started this thread.

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Post by nisiprius » Wed Oct 22, 2008 3:52 pm

linenfort wrote:I don't know if this has been posted - Taleb was on Newshour yesterday
evening. Scared the life out of me, before I got over it.

http://www.pbs.org/newshour/bb/business ... 10-21.html
This spoke to me:
We live in a world that is way too complicated for our traditional economic structure. It's not as resilient as it used to be. We don't have slack. It's over-optimized.
Henry Petroski has written a number of fantastic books, some on the role of error and failure in engineering. The one I'm probably thinking about is To Engineer Is Human: The Role of Failure in Successful Design.

The first thing is that engineers traditionally have something called "the margin of ignorance." This is a large factor, e.g. a factor of three, that is thrown in to allow for the fact that your understanding of the system is imperfect. (I first ran into it myself when I was a kid building electronics projects, and couldn't figure out why the books said that you should spec a capacitor with a "working voltage" three times as high as the actual voltage is was, well, designed to work with in the circuit you were building.)

It's not just an allowance for metal fatigue or for discovering, as Roebling did during the building of the Brooklyn Bridge that the cables you've already installed were from a dishonest supplier and slightly subpar. It's an allowance for the "unknown unknowns."

Anyway, as I remember it, Petroski thinks there's a definite cycle in which economic pressures and the illusion of understanding tend to erode the margin of ignorance over time, until some catastrophic failure brings home the realization that the engineers really didn't know everything that was going on. (And brings home the realization to the managers that the engineers' insistence on building things three times as strong "as needed" according to the computer model, isn't just perverse overconservatism).
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Re: Financial Hell from Taleb's POV

Post by superlight » Wed Oct 22, 2008 4:06 pm

HerbertSitz wrote:Frankly, I think that method of management (i.e, your method) is a very good thing, and I don't understand why you seem to want throw your hat fully in the ring with Taleb. Taleb would _never_ approve of having a client portfolio invested 80% in stocks. Taleb would _never_ approve of a TSM/TBM allocation. Yes, you may be in minor agreement with him regarding a thing or two, but his is basically a radical position that's far, far outside the mainstream of acceptable portfolio management.
That's interesting. I am building a TSM/TBM portfolio, and I appreciate a lot of the Taleb/Mandelbrot message. Of course, what we are seeing now is that TSM/TBM can take a solid hit, together. Bogle might agree that yes, that much is a given. Bogle points to long term data that says they'll come back. Do Taleb/Mandelbrot disagree with that? Or are they more focussed on the short term pain?
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Post by Lbill » Wed Oct 22, 2008 4:09 pm

Nisiprius - Wonderful analogy. Being familiar with engineers and engineering I remember well the concept of "over-building," which again refers to the margin of error. And these guys actually DO understand the math! I'll keep this example clearly in mind. I generally think that Taleb's idea of "overbuilding" a portfolio with the safest (most predictable) assets make a lot of sense - especially at my stage of life. He is talking a lot about "uncertainty" and not risk. Jack Bogle in "Black Monday and Black Swans" also talked about uncertainty. He also said that contemporary financial markets were becoming a lot more complex and uncertain than ever before - inviting the unexpected. There is just a lot more uncertainty about stocks and stock market behavior IMO. When you boil Bogle's investment views down, isn't he basically saying that a simple portfolio divided between the risky asset (U.S. stocks) and the "safe" asset (bonds) is the best? As you get older and can afford less risk you should tilt more heavily toward the safe asset. Now maybe Taleb thinks there's even more danger in the stock market than Bogle does, but that's just a debate about allocation percentages, right?
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Post by bobcat2 » Wed Oct 22, 2008 4:18 pm

superlight writes.
I am building a TSM/TBM portfolio, and I appreciate a lot of the Taleb/Mandelbrot message. Of course, what we are seeing now is that TSM/TBM can take a solid hit, together. Bogle might agree that yes, that much is a given. Bogle points to long term data that says they'll come back. Do Taleb/Mandelbrot disagree with that?

Yes, Taleb disagrees with that.

Here's what Taleb says.
“If people knew the risks (of the stock market) they’d never invest.”
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Post by Rodc » Wed Oct 22, 2008 4:22 pm

bobcat2 wrote:superlight writes.
I am building a TSM/TBM portfolio, and I appreciate a lot of the Taleb/Mandelbrot message. Of course, what we are seeing now is that TSM/TBM can take a solid hit, together. Bogle might agree that yes, that much is a given. Bogle points to long term data that says they'll come back. Do Taleb/Mandelbrot disagree with that?

Yes, Taleb disagrees with that.

Here's what Taleb says.
“If people knew the risks (of the stock market) they’d never invest.”
Bob K
And if we knew the risks of having kids we'd never have them either! :)

(but so far I'm darn glad I had kids, here's to hoping I continue to feel that way and feel similarly about owning stocks!)
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Post by bobcat2 » Wed Oct 22, 2008 4:23 pm

Taleb does not believe in investing in asset classes period. He proposes investing most of your assets, say 90%, in whatever you think is the safest financial asset you can find. He advises investing the remaining 10% in options or the stock of individual small companies that appear to be particularly risky, because you may strike gold with one or two companies of the 20 or so you invest in.

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Post by Lbill » Wed Oct 22, 2008 4:25 pm

Taleb does not believe in investing in asset classes period. He proposes investing most of your assets, say 90%, in whatever you think is the safest financial asset you can find. He advises investing the remaining 10% in options or the stock of individual small companies that appear to be particularly risky, because you may strike gold with one or two companies of the 20 or so you invest in
... and this is a bad idea because ....
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Bodie on the 'Hurricane'

Post by bobcat2 » Wed Oct 22, 2008 4:28 pm

Here's a recent Zvi Bodie interview of recent market conditions and what to do about them. I think he is a little long winded here, but it's still an effective antidote to Taleb.

Link:
http://www.bu.edu/phpbin/news-cms/news/ ... mplate=230

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