Fortune’s Formula by Poundstone was recommended inside Safe Haven. The book touched on a number of questions/issues I’ve been pondering since attending Taleb’s seminar in October 2019.
Very helpful book!
What follows are a bunch of points I’m writing down so I can refer back later.
Insurance proceeds: Will I be able to access my money when I need it? Applies to everything, especially exotics.
All families are sellers, eventually.
This is an important point because crashes are most damaging when one is forced to sell into them. Ironic point is many (most?) of us choose to sell into them (or in fear of them).
Recently, I came across an article about CalPERS selling billions into a dip – even smart people make poor decisions, most often when they are custodians of other people’s money.
Most institutions have shorter memories than families. Keep reminding yourself of your mistakes – you probably paid a lot to learn your lessons.
Train yourself, and your kids, to be able to tolerate bad news. It saves time, money and emotion.
Counter-party Risk
Payout => who’s on the other side of my insurance trade and are they going to need a bailout to pay me? If my insurance company might need a bailout then am I really insured?
I’ve done my best deals when all buyers have disappeared. A delay in payout can have a huge opportunity cost to me.
Skill => reading financial history, I notice the people on the other side have… better analytical skill, superior computing power, faster capacity to execute, better (and inside) information, favorable leverage terms, assistance with “techniques” to defer/avoid/evade taxation.
These folks are on the other side of everything I do.
Ruin
Steer clear of most bets where there’s a chance you could lose all your money. Many useful examples in the book.
This doesn’t mean to avoid all loses inside a portfolio. Highly volatile bets can make sense when limited in size.
This does mean avoid creating a portfolio (or lifestyle!) with the potential for total loss.
Kelly Criterion
I do not have faith in my calculations of the probably of real-world outcomes. For me to use Kelly, I need to have a feel for the odds of various outcomes.
Using Kelly weighting (even fractional) runs the risk of fooling myself about the total amount of risk I am taking on. There’s probably a way to work backwards and see the implied odds within various prices – I do not have confidence in my capacity to compete with experts in the arbitrage pricing domain.
That said, the key point I took from the discussion, “never bet an amount that results in a chance, any chance, you’ll be removed from the game.” This calculation is simple to calculate and easy to execute.
Downturns & Drawdowns
With this in mind, there’s an important point about investing for long-term wealth. The likelihood of a major drawdown and the cyclical nature of exponential growth.
Put simply, most families, using a long-term wealth maximizing strategy, will spend a lot of time being “less wealthy than they used to be”. Page 228 of the 1st hardcover edition.
BIG POINT: many families trade a ton of return to avoid this reality // OR // over-bet in the short-term in an effort to avoid normal downward wealth fluctuations.
Worth emphasizing! Most people trade long-term return or increase their risk of ruin to avoid natural fluctuations in wealth (and fitness, for that matter).
Very few people have the emotional make up to roll with the punches when it comes to volatility.
One way to hedge yourself is to maintain the capacity to cut spending so you maintain your “net worth / cash burn” ratio. I write about this a lot because it can give you an emotional edge during a crisis.
Buyer Beware
OK, you say to yourself, I don’t understand how to tail risk hedge so I’m going to use an outside expert to do it for me.
Not so fast!
Focus on your day job. Be really excellent at what you know well. In your financial life, be extremely conservative.
Because…
In every field I’ve gotten to know well…
As a class, insiders consume the excess return for themselves.
…private equity, CEOs, elective-medicine, sports supplements, luxury goods, commercial banking…
Excess returns come from inside a field where you are world-class, not from tinkering on the other side of a trade with a finance whiz.
Feel The Byrn 
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