the right places.*
What you should avoid is unnecessary dependence on large-scale
harmful predictions—those and only those. Avoid the big subjects that
may hurt your future: be fooled in small matters, not in the large. Do not
listen to economic forecasters or to predictors in social science (they are
mere entertainers), but do make your own forecast for the picnic. By all
means, demand certainty for the next picnic; but avoid government socialsecurity
forecasts for the year 2040.
Know how to rank beliefs not according to their plausibility but by the
harm they may cause.
Be Prepared
The reader might feel queasy reading about these general failures to see
the future and wonder what to do. But if you shed the idea of full predictability,
there are plenty of things to do provided you remain conscious
of their limits. Knowing that you cannot predict does not mean that you
cannot benefit from unpredictability.
The bottom line: be prepared! Narrow-minded prediction has an analgesic
or therapeutic effect. Be aware of the numbing effect of magic
numbers. Be prepared for all relevant eventualities.
THE IDEA OF POSITIVE ACCIDENT
Recall the empirics, those members of the Greek school of empirical medicine.
They considered that you should be open-minded in your medical
diagnoses to let luck play a role. By luck, a patient might be cured, say, by
* Dan Gilbert showed in a famous paper, "How Mental Systems Believe," that we
are not natural skeptics and that not believing required an expenditure of mental
effort.
2 0 4 WE J U S T C A N ' T PREDICT
eating some food that accidentally turns out to be the cure for his disease,
so that the treatment can then be used on subsequent patients. The positive
accident (like hypertension medicine producing side benefits that led
to Viagra) was the empirics' central method of medical discovery.
This same point can be generalized to life: maximize the serendipity
around you.
Sextus Empiricus retold the story of Apelles the Painter, who, while
doing a portrait of a horse, was attempting to depict the foam from the
horse's mouth. After trying very hard and making a mess, he gave up and,
in irritation, took the sponge he used for cleaning his brush and threw it
at the picture. Where the sponge hit, it left a perfect representation of the
foam.
Trial and error means trying a lot. In The Blind Watchmaker, Richard
Dawkins brilliantly illustrates this notion of the world without grand design,
moving by small incremental random changes. Note a slight disagreement
on my part that does not change the story by much: the world,
rather, moves by large incremental random changes.
Indeed, we have psychological and intellectual difficulties with trial and
error, and with accepting that series of small failures are necessary in life.
My colleague Mark Spitznagel understood that we humans have a mental
hang-up about failures: "You need to love to lose" was his motto. In
fact, the reason I felt immediately at home in America is precisely because
American culture encourages the process of failure, unlike the cultures of
Europe and Asia where failure is met with stigma and embarrassment.
America's specialty is to take these small risks for the rest of the world,
which explains this country's disproportionate share in innovations. Once
established, an idea or a product is later "perfected" over there.
Volatility and Risk of Black Swan
People are often ashamed of losses, so they engage in strategies that produce
very little volatility but contain the risk of a large loss—like collecting
nickels in front of steamrollers. In Japanese culture, which is
ill-adapted to randomness and badly equipped to understand that bad
performance can come from bad luck, losses can severely tarnish someone's
reputation. People hate volatility, thus engage in strategies exposed
to blowups, leading to occasional suicides after a big loss.
Furthermore, this trade-off between volatility and risk can show up in
A P P E L L E S THE PAINTER, OR WHAT DO YOU DO IF Y O U CANNOT P R E D I C T ? 2 0 5
careers that give the appearance of being stable, like jobs at IBM until the
1990s. When laid off, the employee faces a total void: he is no longer fit
for anything else. The same holds for those in protected industries. On the
other hand, consultants can have volatile earnings as their clients' earnings
go up and down, but face a lower risk of starvation, since their skills
match demand—fluctuat nec mergitur (fluctuates but doesn't sink). Likewise,
dictatorships that do not appear volatile, like, say, Syria or Saudi
Arabia, face a larger risk of chaos than, say, Italy, as the latter has been in
a state of continual political turmoil since the second war. I learned about
this problem from the finance industry, in which we see "conservative"
bankers sitting on a pile of dynamite but fooling themselves because their
operations seem dull and lacking in volatility.
Barbell Strategy
I am trying here to generalize to real life the notion of the "barbell" strategy
I used as a trader, which is as follows. If you know that you are vulnerable
to prediction errors, and if you accept that most "risk measures"
are flawed, because of the Black Swan, then your strategy is to be as hyperconservative
and hyperaggressive as you can be instead of being mildly
aggressive or conservative. Instead of putting your money in "medium
risk" investments (how do you know it is medium risk? by listening to
tenure-seeking "experts"?), you need to put a portion, say 85 to 90 percent,
in extremely safe instruments, like Treasury bills—as safe a class of
instruments as you can manage to find on this planet. The remaining 10 to
15 percent you put in extremely speculative bets, as leveraged as possible
(like options), preferably venture capital-style portfolios.* That way you
do not depend on errors of risk management; no Black Swan can hurt you
at all, beyond your "floor," the nest egg that you have in maximally safe
investments. Or, equivalently, you can have a speculative portfolio and insure
it (if possible) against losses of more than, say, 15 percent. You are
"clipping" your incomputable risk , the one that is harmful to you. Instead
* Make sure that you have plenty of these small bets; avoid being blinded by the
vividness of one single Black Swan. Have as many of these small bets as you can
conceivably have. Even venture capital firms fall for the narrative fallacy with a
few stories that "make sense" to them; they do not have as many bets as they
should. If venture capital firms are profitable, it is not because of the stories they
have in their heads, but because they are exposed to unplanned rare events.
2 0 6 WE J U S T C A N ' T P R E D I CT
of having medium risk, you have high risk on one side and no risk on the
other. The average will be medium risk but constitutes a positive exposure
to the Black Swan. More technically, this can be called a "convex" combination.
Let us see how this can be implemented in all aspects of life.
"Nobody Knows Anything"
The legendary screenwriter William Goldman was said to have shouted
"Nobody knows anything!" in relation to the prediction of movie sales.
Now, the reader may wonder how someone as successful as Goldman can
figure out what to do without making predictions. The answer stands perceived
business logic on its head. He knew that he could not predict individual
events, but he was well aware that the unpredictable, namely a
movie turning into a blockbuster, would benefit him immensely.
So the second lesson is more aggressive: you can actually take advantage
of the problem of prediction and epistemic arrogance! As a matter
of fact, I suspect that the most successful businesses are precisely those
that know how to work around inherent unpredictability and even exploit
it.
Recall my discussion of the biotech company whose managers understood
that the essence of research is in the unknown unknowns. Also,
notice how they seized on the "corners," those free lottery tickets in the
world.
Here are the (modest) tricks. But note that the more modest they are,
the more effective they will be.
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,
A P P E L L E S THE PAINTER, OR WHAT DO YOU DO IF Y O U CANNOT P R E D I C T ? 2 0 7
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
2 0 8 WE J U S T C A N ' T P R E D I CT
this additional uncertainty, since it cannot hurt you and can only
benefit you.*
b. Don't look for the precise and the local. Simply, do not be narrowminded.
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.
c. Seize any opportunity, or anything that looks like opportunity.
They are rare, much rarer than you think. Remember that positive
Black Swans have a necessary first step: you need to be exposed to
them. Many people do not realize that they are getting a lucky
break in life when they get it. If a big publisher (or a big art dealer
or a movie executive or a hotshot banker or a big thinker) suggests
* There is a finer epistemological point. Remember that in a virtuous Black Swan
business, what the past did not reveal is almost certainly going to be good for you.
When you look at past biotech revenues, you do not see the superblockbuster in
them, and owing to the potential for a cure for cancer (or headaches, or baldness,
or bad sense of humor, etc.), there is a small probability that the sales in that industry
may turn out to be monstrous, far larger than might be expected. On the other
hand, consider negative Black Swan businesses. The track record you see is likely
to overestimate the properties. Recall the 1982 blowup of banks: they appeared to
the na?ve observer to be more profitable than they seemed. Insurance companies
are of two kinds: the regular diversifiable kind that belongs to Mediocristan (say,
life insurance) and the more critical and explosive Black Swan-prone risks that are
usually sold to reinsurers. According to the data, reinsurers have lost money on underwriting
over the past couple of decades, but, unlike bankers, they are introspective
