The Black Swan: The Impact of the Highly Improbable

a. First, make a distinction between positive contingencies and negative ones. Learn to distinguish between those human undertakings in which the lack of predictability can be (or has been) extremely beneficial and those where the failure to understand the future caused harm. There are both positive and negative Black Swans. William Goldman was involved in the movies, a positive-Black Swan business. Uncertainty did occasionally pay off there.

A negative-Black Swan business is one where the unexpected can hit hard and hurt severely. If you are in the military, in catastrophe insurance, or in homeland security, you face only downside. Likewise, as we saw in Chapter 7, if you are in banking and lending, surprise outcomes are likely to be negative for you. You lend, and in the best of circumstances you get your loan back—but you may lose all of your money if the borrower defaults. In the event that the borrower enjoys great financial success, he is not likely to offer you an additional dividend.

Aside from the movies, examples of positive-Black Swan businesses are: some segments of publishing, scientific research, and venture capital. In these businesses, you lose small to make big. You have little to lose per book and, for completely unexpected reasons, any given book might take off. The downside is small and easily controlled. The problem with publishers, of course, is that they regularly pay up for books, thus making their upside rather limited and their downside monstrous. (If you pay $10 million for a book, your Black Swan is it not being a bestseller.) Likewise, while technology can carry a great payoff, paying for the hyped-up story, as people did with the dot-com bubble, can make any upside limited and any downside huge. It is the venture capitalist who invested in a speculative company and sold his stake to unimaginative investors who is the beneficiary of the Black Swan, not the “me, too” investors.

In these businesses you are lucky if you don’t know anything—particularly if others don’t know anything either, but aren’t aware of it. And you fare best if you know where your ignorance lies, if you are the only one looking at the unread books, so to speak. This dovetails into the “barbell” strategy of taking maximum exposure to the positive Black Swans while remaining paranoid about the negative ones. For your exposure to the positive Black Swan, you do not need to have any precise understanding of the structure of uncertainty. I find it hard to explain that when you have a very limited loss you need to get as aggressive, as speculative, and sometimes as “unreasonable” as you can be.

Middlebrow thinkers sometimes make the analogy of such strategy with that of collecting “lottery tickets.” It is plain wrong. First, lottery tickets do not have a scalable payoff; there is a known upper limit to what they can deliver. The ludic fallacy applies here—the scalability of real-life payoffs compared to lottery ones makes the payoff unlimited or of unknown limit. Secondly, the lottery tickets have known rules and laboratory-style well-presented possibilities; here we do not know the rules and can benefit from this additional uncertainty, since it cannot hurt you and can only benefit you.[44]

b. Don’t look for the precise and the local. Simply, do not be narrow-minded. The great discoverer Pasteur, who came up with the notion that chance favors the prepared, understood that you do not look for something particular every morning but work hard to let contingency enter your working life. As Yogi Berra, another great thinker, said, “You got to be very careful if you don’t know where you’re going, because you might not get there.”

Likewise, do not try to predict precise Black Swans—it tends to make you more vulnerable to the ones you did not predict. My friends Andy Marshall and Andrew Mays at the Department of Defense face the same problem. The impulse on the part of the military is to devote resources to predicting the next problems. These thinkers advocate the opposite: invest in preparedness, not in prediction.

Remember that infinite vigilance is just not possible.