In 2002, Malcolm Gladwell wrote a piece for the New Yorker called "Blowing Up." It details the investment strategies — and the life philosophy — of two options traders, Victor Niederhoffer and Nassim Nicholas Taleb. What is revealed in these investment strategies is a vivid portrait of two different ways to assess risk.
In Niederhoffer, risk assessment is focused on the potential gain. How many small, safe bets can I win to offset or justify the potential catastrophic loss? For Taleb it is the opposite: How can I guarantee that I avoid catastrophe while also exposing myself to the potential for upside gains?
The tale points out that our culture venerates and rewards those willing to assume great risk — the Niederhoffers of the world — yet it is the Taleb mentality, the idea of sacrificing easy gains today for the sake of tomorrow's strength and stability, that is the more difficult path. And for us at Strong Towns, that's the more heroic way forward.
The United States federal government calls on investors to assess their risk tolerance. Their framework is one that is adopted by fund managers and brokerage firms across the country. If you've even invested money, you've likely been exposed to something like the following, which is from the SEC website, Investor.gov:
When it comes to investing, risk and reward go hand in hand. The phrase “no pain, no gain” – comes close to summing up the relationship between risk and reward. Don’t let anyone tell you otherwise: all investments involve some degree of risk. If you plan to buy securities – such as stocks, bonds, mutual funds, or ETFs – it’s important that you understand that you could lose some or all of the money you invest.
An aggressive investor, or one with a high risk tolerance, is willing to risk losing money to get potentially better results. A conservative investor, or one with a low risk tolerance, favors investments that maintain his or her original investment.
What if this is not acceptable? What if you are not willing to risk losing all of your money, but you're also not willing to merely preserve what you have? Is this kind of blended portfolio — picking a point along a risk scale between burying your money in the back yard and going to a casino — the only way to look at investing?
Not if you're Nassim Taleb, and not if you're Strong Towns president Charles Marohn. In this podcast, Marohn details his own investment strategy — a personalized version inspired by Taleb — to reduce risk, never blow up, and have a reasonable chance of upside gain.
Marohn's current allocation is:
- Cash: 65%
- Metals: 15%
- Oil: 5%
- International Dividend-Paying Stocks: 10%
- Small, high upside stocks: 5%
In investment circles, this is a modified version of the barbell strategy. Investopia explains the strategy like this:
Nassim Nicholas Taleb, the renowned derivatives trader and arbitrageur whose unorthodox methods enabled him to profit stupendously in 2007-08 when some of Wall Street’s ostensibly sharpest cookies were getting burned, phrases the barbell strategy’s underlying principle as follows:
"If you know that you are vulnerable to prediction errors, and […] accept that most “risk measures” are flawed, then your strategy is to be as hyperconservative and hyperaggressive as you can be instead of being mildly aggressive or conservative."
Can cities adopt the barbell strategy? Back in 2013, we shared an essay detailing how cities needed to have two mindsets — have eggs in two baskets — the conservative banking mentality and the venture capital mentality. Updated in 2016, Marohn's essay, "The Barbell Strategy," is essential reading. Local governments have a moral duty to pursue growth and investment strategies that have no chance of blowing up, yet they all generally pursue the more socially acceptable blended portfolio, one where they make large investments that have modest upside potential yet are very risky to the downside.
The approach detailed in Marohn's essay "Poor Neighborhoods Make the Best Investments" as well as in our Neighborhoods First report, provide a better road map for cities looking to maximize their gains while protecting their citizens from downside loss.