Nassim Taleb is an essayist, statistician, and former trader/risk analyst. He is one of my favorite authors, and if you ever want to be humbled in your intellect, reading his work may do it for you as it has for me.
In his book, Antifragile, Taleb advocates for a system wherein “things benefit and grow from a certain class of random events, errors, and volatility.” He proposes that this already occurs in many realms of science and society by means of decentralized systems.
How do you benefit from this concept in your financial planning and portfolio construction?
Investment markets will have unavoidable setbacks. Trees do not grow straight up to the sky, and investments experience retractions. Unavoidable setbacks do not have to be unrecoverable ones. My definition of unrecoverable is that YOU have to reduce your lifestyle because of the investment market behavior. This definition is key. It moves the issue to what you can control.
Fragile, Brittle, Resilient
A fragile portfolio is one that is flimsy and delicate. It can’t hold up your lifestyle under most circumstances. A portfolio that is invested entirely in fixed income or cash is fragile. You may hold CD’s, government bonds, or corporate bonds. It feels strong because your dollar value rarely goes in the red. But, if you look at the long-term return history, this type of portfolio does not keep up with inflation or does so just barely. It doesn’t maintain your lifestyle in a decade or two.
A brittle portfolio seems like it is built to last, but once it hits a certain stress point, it snaps. A portfolio that is invested entirely in tech stocks is fragile. Alternatively, one wholly invested in banks is fragile. Frankly, a portfolio is vulnerable when it is invested in any one or two areas of the market. For a period of time, sometimes long, it can work; but at some point, the dot com bubble, the Financial Crisis, or the 4th quarter of 2018 occurs, and the portfolio is broken.
A resilient portfolio is able to withstand and recover from difficult conditions. How do you build this? Let’s go back to Taleb’s concept noted in my second paragraph; a system wherein “things benefit and grow from a certain class of random events, errors, and volatility.” Again, he proposes that this can occur by means of decentralized systems.
Decentralizing your Portfolio
A decentralized system when it comes to portfolio construction would mean not putting all of your assets in one place, such as small U.S. equities, or the technology industry, or banking and financials, or real estate.
A system where things benefit or even grow from volatility could be one in which you had the flexibility to act, or not act, in the face of rapid change. This could be buying more of an asset when prices drop quickly.
On the other hand, a system where things benefit from random events may mean you are not forced to act at all, and you can let others who fall prey to their emotions make unrecoverable decisions.
These are just two examples of how resilience can create a sustainable and appropriate portfolio for each investor. This is what we do in order to keep a focus on the primary objective; helping you to not have to reduce your lifestyle due to investment market behavior.
A Final Thought
When we raise our children, we want them to be resilient. The reality is that we can’t remove setbacks or difficult conditions from their lives. We can’t control everything. That is not realistic if we want a well-adjusted, growing, and productive child. Your portfolio should be the same. We cannot hide it from difficult times and have it grow. We do not have to shield it from short-term setbacks. We cannot control everything that happens and expect to have a well-adjusted, growing, and productive portfolio that allows you to keep your lifestyle for years to come. The final quarter of 2018 was distressing and unwelcome. But if your portfolio is resilient, you will be able to handle the stress it induced.
Author: David Jeter, CFP® | Partner and Financial Advisor | Allegheny Financial Group | February 2019
The information included herein was obtained from sources which we believe reliable. This report is being provided for informational purposes only. It does not represent any specific investment and is not intended to be an offer of sale of any kind. Past performance is not a guarantee of future results.
Allegheny Financial Group is a Registered Investment Advisor. Securities offered through Allegheny Investments, LTD, a registered Broker/Dealer. Member FINRA/SIPC.