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The Barbell Strategy: The 90/10 Rule for Taking Risks

We’ve talked about strategies to take risks before. And, in particular, about making sure that, whatever you do, you don’t blow up. So, today we want to build upon this idea, introducing a new concept: The Barbell Strategy. 

A tiny bit of History.

We have also dedicated space and time to talk about Nassim Nicholas Taleb, the Lebanese-American author of The Black Swan, mathematic, and known slow-walker (among many other occupations.) On this occasion, we’ll touch on the details of the risk-taking strategy he discusses in Antifragile, inspired by his weightlifting interest.

Robustness and balance. 

Take a classic barbell, such as the ones you could find in a weightlifter’s bedroom (the kind that doesn’t use machines.)  With more or less weight on both its ends, an adequate barbell would look like this:

A classic Barbell, your best friend against risk.

Taleb introduces the barbell analogy to present the idea of optionality, that is, establishing a definite downside when taking risks, always making sure that these have an unlimited upside. Optionality, also referred to by the author as positive convexity, is present in every situation with well-defined (small) negative pay-offs (such as financial options, accidents in an insured car, or losing at blackjack), and great exposition to positive, random outcomes (such as stumbling upon a literal treasure, creating a hit song, or creating Reddit). 

The fact that you understand optionality doesn’t mean you should immediately crash your car, gamble your life away at blackjack, or spend your life savings in Bitcoin. For, as you can see below, the barbell indicates the need for extreme caution: 

90% of the barbell represents its total weight, leaving the bar to be manipulated by the weightlifter. 

The image above showcases that, when taking risks, understanding the concept of optionality is just the beginning: After this, one needs to distribute the risk further correctly, safeguarding (approximately) 90% of his resources. Some examples of this distribution could be:

  • In finance, allocating 90% of our funds to minimum-risk portfolios designed only as a hedge against inflation.
  • When undertaking a risky activity (such as starting a business), making sure that we do so in a way that doesn’t compromise 100% of our stability. 
  • Avoiding constant or chronic stress or rage, but allowing ourselves to experience these emotions that, in moderate quantity, can be physically and mentally beneficial. 

The fun, part, however, is what happens with the remaining 10%.

Risk doesn’t sound so bad when it can only bring positive outcomes, does it?

The juicy part of the barbell is, precisely, the middle. Once you have correctly safeguarded yourself from total blow-up (which is a more likely scenario than we tend to think), we can afford to undertake risks. Of course, it goes without saying that we should only take risks with an unlimited positive outcome, as those are also more likely to happen than we tend to think. 

As using our remaining 10% for fun and profit allows us to be positively exposed to extreme outcomes without a significant downside, using the previously cited examples we could:

  • After allocating 90% of our funds to minimum-risk portfolios designed only as a hedge against inflation, use the remaining 10% to invest in speculative assets (preferably, with a clear downside as well, such as options).
  • When sure that starting a business won’t destroy our stability, allowing ourselves to use a fail-fast-and-inexpensively, Silicon Valley-like approach to test ideas and find highly profitable ones.
  • With our mental state in control and under-check, undertaking stressful activities with potential for high rewards selectively and during limited amounts of time.

May volatility be with you.

Before parting, we’d like to highlight that, while the 90/10 rule might seem easy to apply, it requires both rigour and diversification. It doesn’t mean that you shouldn’t diversify even within the volatile 10%, or that you shouldn’t look to allocate your time and resources to things that you think have the potential to strike gold. With the easy example of finance, if you were to allocate your risky 10% to purchase shares in 10 different companies, with 9 of them going bust and one achieving a rare 100x, your overall portfolio would still have increased by 91%. 

We hope that this article helps you in life, and we salute Mr Taleb!

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