Monday, May 14, 2018

Skin in the Game

We’ve heard that free advice is worth what you pay for it. In his latest book, Skin in the Game, Nassim Taleb takes this much further saying “do not pay attention to what people say, only to what they do, and how much of their necks they are putting on the line.” Most of his book is devoted to explaining the many contexts where the idea of skin in the game applies.

Like Taleb’s other books, this one is filled with many ideas worth thinking about along with many hurled insults at those he calls Intellectuals Yet Idiots (IYIs). There is even name-calling: “Hillary Monsanto-Malmaison, sometimes known as Hillary Clinton.” If Taleb’s accusations are accurate, then some of these people (but not all) deserve his insults and more, but they are tedious nonetheless. Despite all this, I’d rather read a book with a few good ideas and some unpleasant parts than read a pleasant book with nothing important to say.

I was unable to follow the logic of parts of the book, and some topics didn’t seem to have much connection to the concept of skin in the game. For the rest of this review, I’ll avoid these topics.

“Don’t tell me what you ‘think,’ just tell me what’s in your portfolio.” This is something I’ve tried to stick to on my blog when I discuss investing. I say how I invest, and explain why I avoid other investments, but I try to avoid recommending investments I don’t own myself. I’m suspicious of those who recommend investments they don’t own themselves.

Taleb extends this beyond just investing: “those who don’t take risks should never be involved in making decisions.” He doesn’t like it when government bureaucrats make decisions about wars or regulations when they have little to lose themselves. “Administrators everywhere on the planet, in all businesses and pursuits, and at all times in history, have been the plague.”

“The principal thing you can learn from a professor is how to be a professor—and the chief thing you can learn from a life coach or inspirational speaker is how to become a life coach or inspirational speaker.” He says the heroes of history weren’t library rats, but were “people of deeds [who] had to be endowed with the spirit of risk taking.”

“Beware of the person who gives advice, telling you that a certain action on your part is ‘good for you’ while it is also good for him, while the harm to you doesn’t directly affect him.” This applies in many areas, one of which is financial advice. Typically, advisors get a percentage of your assets, not a percentage of your gains and losses.

“Behavioral economics [fails] to give us any more information than orthodox economics (itself rather poor) on how to play the market or understand the economy, or generate policy.” I see behavioral economics having two purposes: a positive one to try to help people make better personal financial decisions, and a negative one to help retailers and other sales organizations better exploit their customers’ weaknesses.

Taleb criticizes Thomas Piketty’s book, Capital in the Twenty-First Century. On Picketty’s method of measuring inequality: “Static inequality is a snapshot view of inequality; it does not reflect what will happen to you in the course of your life.” For example, the 25-year old version of me had much lower income and assets than the recent version of me. Measured statically, inequality seems bigger than it really is.

Measures of income inequality are dominated by the wealthiest people (the “tail” of the wealth distribution). This tail is a “fat tail” and the standard mathematical tools used by economists assume thin tails.

I suspect that Piketty wouldn’t be overly concerned with these criticisms. Even if we correct the way inequality is measured, Piketty would likely still call for huge tax increases. I’ve written before what I think of these proposed taxes. Taleb says “Any form of control of the wealth process—typically instigated by bureaucrats—tends to lock people with privileges in their state of entitlement.” He would rather have inequality with turnover among the wealthiest.

“Academia has a tendency, when unchecked (from lack of skin in the game), to evolve into a ritualistic self-referential publishing game.” I’ve seen this happen in my own field to some extent. However, the best researchers don’t engage in publishing games; it’s the next tier down who do these things because are struggling for survival as researchers. A field or subfield faces problems when the best researchers abandon it to those most concerned with getting publications.

“Consider that a recent effort to replicate the hundred psychology papers in ‘prestigious’ journals of 2008 found that, out of a hundred, only thirty-nine replicated.” Because human nature was “available to the ancients,” “everything that holds in social science and psychology has to ... have an antecedent in the classics.” I agree that we should be skeptical of new findings, but I reject the idea that it’s impossible for us to learn something new about human nature.

“Executives are different from entrepreneurs and are supposed to look like actors.” I’ve certainly seen a lot of this in my business career. Whether an executive has genuine skill at running an organization effectively or not, he or she almost invariably acts the part.

I’ve often wondered about the apparent gap between grocery store prices and what farmers get paid. According to Taleb, “close to 80 to 85 percent of the cost of a tomato can be attributed to transportation, storage, and waste (unsold inventories), rather than the cost at the farmer level.”

There is a posh area a few kilometers from my home with huge houses on big lots. I see few people when I walk through the area on a sunny Saturday afternoon. The few children I see look lonely. Taleb observes “nobody today will come to console you for living in a mansion—few will realize that it is quite sad to be there on a Sunday evening.”

On “The Ethics of Disagreement,” Taleb says “You can criticize either what a person said or what a person meant.” I’ve certainly had my fill of critics who deliberately take statements out of context. Politics consists of little else.

The book contains criticism for the ideas of risk aversion and loss aversion. I write about this part of the book in a piece called Does Loss Aversion Exist?

On the subject of Genetically-Modified Organisms (GMOs), Taleb believes that by making sudden genetic changes rather than making gradual changes with conventional breeding, we risk creating an organism that grows out of control and destroys our ecosystem. He believes that no benefit we get from GMOs could outweigh this potential loss.

Overall, I’m glad I read this book. Some parts were tedious, but the few parts that made me think about a subject in a different way more than compensated.


  1. Michael, I haven't read the book yet, but we are big believers of the overall concept of 'Skin in the Game'. At Steadyhand, we publish every year the percentage of our team's financial assets that are invested alongside our clients in our funds. The latest number is 91%. TB

    1. @Tom: I think this is an important sign for investors. Why should any investor choose a fund if those who run and sell the fund won't choose it themselves?

  2. "Typically, advisors get a percentage of your assets, not a percentage of your gains and losses." Typical is a bit of an understatement don't you think? The only exception I can think of is hedge funds are happy to additionally take a percentage of your gains but I've never seen one that pays you back a percentage of your losses. Where are the advisors that pay you back a percentage of your losses, I've been looking for them a long time :).

    91% skin in the game at Steady Hand is a good sign I agree. I suspect that Steady Hand employees don't pay the same management fees as their customers though.

    1. @Greg: Yes, it is an understatement. I've found that understatement can be an effective way to draw in those new to an idea. I could say that investment fees typically consume 1/3 to 1/2 of your savings over a lifetime and that the advisor/manager take virtually none of the risk, but this just sounds unbelievable to most, even though it's true.

      The only example of an arrangement I can recall where investors were entitled to be paid back a percentage of their losses was with early Buffett partnerships. I don't remember where I read that -- perhaps one of his biographies.

    2. Hi Greg, I am happy to confirm that we (Steadyhand employees) pay the same fees as our clients. No discounts aside from the size and tenure breaks that all investors enjoy. We also have no sales targets, either individually or firm wide. No one at Steadyhand is paid a commission or bonus directly related to AUM growth.

  3. The concept I have is that if any course/book/movie/whatever gives me three things to think about from it, then they are a success. If it is a very long book, then maybe a few more than that.

    1. @Alan: I'll settle for just one new idea from a book if that one idea is interesting or important enough.

  4. Thanks for the summary of this book .I have read Talebs other books, but not this one yet...been meaning to.

    I think you summarized my feelings of him well. Overall there's an air of cantankerousness mixed with a bit of condescension that I could do without, but I have found his other books to admittedly contain some unique and hard-to-refute arguments.

    Will try to pick this one up to read soon.