Posted: 12 Oct 2008 09:00 PM CDT

We live in a world of black swans.

In a nutshell, that is what Nassim Nicholas Taleb’s (NNT) book “The Black Swan: The Impact of the Highly Improbable” talks about. He shares with us how the world is more random and unpredictable than we think it is. What’s worse is that in the world of finance, financial institutions and hedge funds who make risky investments think that they are able to predict with some degree of precision about both the likelihood and impact of their investments. Current events show how misguided the financial world was in allowing their greed to blind them to the systemic risks they were putting the global financial system.

What is a Black Swan?

We see now (in horror when our portfolio values get hit hard) of how prescient NNT was in being able to point out the huge risks being taken by institutions such as Fannie Mae who was nationalised by the US Government. The amazing thing was that NNT himself spells out clearly that he cannot predict since the whole idea of black swans is that they are events that have the following qualities: “rarity, extreme impact, and retrospective (though not prospective) predictability.”

I would not be able to do justice to summarise the key ideas in the book and would urge you to visit NNT’s website which contains reviews done by journalists. I found the review by Bloomberg to provide a quick understanding of his key ideas. Bits of his book can be found here in this Forbes article written by NNT. “The Black Swan” ranks among one of the most influential books I have ever read and the timing of my selection of this book is also serendipitous. Even as the global financial credit crisis unfolded through the dramatic freefall of global equity markets, I was turning each and every page and seeing how NNT’ ideas were being played out in real time through the scrolling red figures of major global equity indices. those who are interested in personal finance and what to make of the current global financial crisis.

What Panzer has learnt from the Black Swan

After spending $1.55 in reserving the book at our public library, I have reaped returns manifold (a personal black swan? ) in being better able to understand randomness in our world. I realise that in the world of Extremistan, there is very little predictive ability on the part of anyone no matter how expert he claims he is. This somewhat gels with my own inate suspicion of financial planners, bank relationship managers (think Lehman Mini-bonds and DBS High Notes debacle) who can advise you about the next big think but not about treasury bills. NNT presents many arguments about the flawed approach of experts trying to predict the future based on past data in realms where the Gaussian (or Bell Curve)’s assumptions do not hold water. If you don’t understand what the previous sentence means, don’t worry. I didn’t understand it at first but got the whole message. In the world of markets and wealth creation, your guess about what will make money is as good as anyone else (or no-one else!)

Taking Risks using Black Swan Ideas

I learnt from NNT that perhaps my approach to investment in buying blue chips and equities and growing my nest egg towards financial freedom needs a rethink. NNT himself suggests a barbell approach to investing, i.e. putting 90-95% of your net worth in treasuries or suitably ultra-safe investments while exposing 5-10% of your net worth or investible savings to potential financial black swans such as start-ups and speculative ventures. NNT himself made what he likes to term “f***-you” money through buying out of the money eurodollar futures that made $35-40million when the US dollar tanked in the late 1980s.

NNT’s type of investment approach is not for everyone. He once ran an investment fund that worked on that basis of being exposed to small regular losses capped but exposed to significant payoffs should positive black swans occur. Hitting huge payoffs by being exposed to positive black swans (e.g. start-up becoming the next Google or Viagra) with limited downside (only 5-10% of investible savings invested) but potentially unlimited upside is not a game that everyone can take because we are judged on short term performance a lot by our peers and society. Thus, it takes a special kind of character to adopt black swan strategies in investing.

This book has reinvigorated my thinking about how I can achieve financial freedom and alternate ways of looking at investment strategies.

Have you read the book? Do share your ideas, thoughts and opinions about the Black Swan in the comments page.

Be well and prosper.

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