Transcription
This video is sponsored by Hey Boss, the new website builder for business backed by OpenAI.
The idea of erodicity is never cross a river if it's 4 feet deep on average. Okay. Well, if you remember last time I was talking about a grandmother and and so so the idea of using averages and stuff like that. So to do science you got to be able to work with averages. So sometimes they misuse it. And the central problem is that you mistake a vertical average for time average. And let me explain very simply. And that's an error that psychologist made like big time.
If I take a 100 gamblers, I send them to the casino, okay? And for one each for one day, uh, okay, come back, I get the average, uh, expected return from a casino and a law of large numbers works beautifully. You tell him gamble for eight hours. All right, or whatever or or whatever you lose your money and come back, okay, with your P&L. All right, so you can figure out the return you can get from a casino for a certain number of bets. The the works beautifully because casinos are we built casinos because we know probability. That's another one where science but but the rest of the world doesn't work that way.
Now if I send one single uh trader okay one single person to the casino for 100 days okay have complete different picture even if there's a positive expected return so to give you the the the example I give in skin and game is if on day 28 sorry okay let's say that I have 100 indexed by one to 100 and number 28 goes bankrupt number 29 is not affected you're taking the arithmetic average So you add a zero, zero doesn't impact average much by one overn. Whereas if I take a sequence of traders going to the casino and if I on day 28 sorry sequence of single person going to the casino dies then it doesn't get it. All right. So then then you can't because you're taking uh uh the the different it's a complete different process different mathematics and for arithmetic average to match the the the continuous compounded thing you must uh bet in log size.
Okay. So let me give for those who not into trading a very simple example right people come to America and talk about inequality and then they write paper on inequality they do things and there's a French guy who wrote a big book on inequality he doesn't seem to know much about much of anything all right his name is uh Pikati okay talking about inequality he don't realize that to do inequality right you got to take every person throughout her or his life rather than take a static inequality But people say inequality is increasing. There was an article on New York Times saying inequality is increasing. All right? So they said look in 1980 it was this way 201. They're not the same people at the top. So what happened is that people don't know that a more erotic measure is to to say um uh how many Americans will spend at least a year in the top 1% and effectively 15% of Americans or 12%. How many Americans will spend at least a year in the top 10% 60% of Americans? Compare that to Europe that has a flatter structure. Okay, it's very different. So it's like taking a markoff chain and make sure that there are no absorbent barrier, no absorbent probabilities, no unit one or zero probabilities in a markoff chain. So, so that's the problem with the with taking not looking at dynamics for uh for inequality. It's exactly the same problem as risk management.
You see, so for example, when people say, "Oh, it's a fair bet and people are stupid. It's it's a good bet 55 45 like in Richard Sailor's um uh I had a Twitter fight with him and started by you know uh it's irrational to not take that bet." Well, the problem is you got to look at if you keep taking that vet all your life unless you follow a specific policy of Kelly criterion for example which has longs incidentally you're going to go bankrupt even if you have fair odds because you cannot survive you're you're you're not taking arithmetic vertical average you're taking uh so you got to take a strategy that compounds a return this is one example of things that in in in economics that practitioner know and uh to to tell you that Richard Taylor among the his accomplishment I think his central one has been that he found a disease called mental accounting that say the following if you go to a casino and increase your betting with money won from the casino it's called houses money you are irrational because it's the same dollars okay you're committing the fault of mental accounting whereas in fact the only way to survive is if you treat that money you got from a casino as different money. So you're more aggressive with a house's money than you are with your initial endowment for example. So so so there are a lot of mistakes made in psych particularly when psychology meets economics the things blow up. So uh when you take that's in skin of the game I explained it at lengths and in and what I call the the what it says the risk takingaking the whatever something about the I thought it was a nice you know it might be might be useful for people uh the sort of physicalized version of what you're saying has to do with time averages versus ensemble averages. There you go. There you go. Physicists know that because they have egotisticity theories and uh economists don't make the mistake in when they deal with stoastic processes because they want to make sure there's no absorbtion but they make the mistake in psych psychology psychology of economics and a lot of economics feel like inequality because what concerns you is at burst what chance do you have okay not taking a snapshot of society when it's dynamic for example, right? I mean, actually, I didn't know this this thing you said about inequality as a function of time. That's an interesting statement.
Now, let's hear from Nasim. Three more strategies align with a goodity principle. If you have skin in the game, you're going to worry about blow up because it's your money. If you don't have skin in the game, you're CEO of a company or you're a fund manager and any any kind of financial venture, what is your incentive is to print good numbers because you don't pay for the downside. So you print good numbers, you take you you you collect money on on the profits. Annual bonus. Annual bonus. So this I call the generalized Bob Rubin trade. Generalized Robert Rubin trade. He made $100 million at city bank or city core city something over 10 years about 10 years he collected $100 million in compensation. The bank was insolvent in 2008 near insolvent if it weren't for for the taxpayer and it was the last minute. All you had to do is you know write an apology letter. We didn't see these events. It was a black swan named after a book by a very very stubborn man. Okay. or something like that. So that's all you have to do is say I'm sorry, right? You keep your bonus show up to work.
So this you can generalize. It's the same thing with supply chain. With a supply chain, a lot of firms concentrated everything on one supplier instead of being diversified. What did that lead to? Right. Okay. Better bottom line, but what I call pseudo efficiency because they're short that option. And it so happened that if their supplier is in Wuhan, guess what? You got a problem. All right. You got problems. That problem was not doesn't show in the numbers. It shows after it happens. It's the dark side of optimization. Exactly. What I call pseudo optimization. Like if you drive a Ferrari 500 km per hour, you're not going to get there faster than if you ride a bicycle cuz odds are you're never going to get there. and robustness requires uh um uh some kind of uh redundancy to have inventory. People think it's silly to have cash in a bank. You're more robust if you have cash in a bank. You see, and actually even antifragile because you can capture opportunities that way. So you see the idea of having more I know I I wrote in a book actually I wrote in this book about if you have excess inventory people think they're a cost. Okay? If you have excess humus in your basement, okay, the kind of inventory I have in my basement being Lebanese, you know, people think it's a it's not a cost to have extra stockpile for companies because if there's a crisis, there's a squeeze and the other people don't have what you need. The price of the commodity shoots up massively and you can sell it. So having inventory is antifragile.
So could you give people the precautionary principle 101 just to back up? Yeah. Okay. Let me ask you, you're in Paris flying to go to Mexico. Okay. You go to JFK. Mhm. And they tell you they have uncertainty about the skills of the pilot. But we think he's good, but there's uncertainty. What do you do? I do not fly. You're not going to get on that plane. I'm not going to get on that. Okay. Life is too important for me. Mhm. You can take a train. You'll take a You walk. Maybe you ride a bicycle, you know, take a few months, but you're not going to get on that plane, right? Okay. You change your plans and say, "Okay, there are other plans or other countries to and other planes though." Mhm. That's Warren Buffett with his investments. But that's micro principle. The idea that there's an asymmetry. Mhm. Is that there's when uncertainty about certain things is not good. Mhm. So the climate for example, if you have uncertainty about the climate, stop these models. All right? just don't pollute. You got or or or try to use something else. Try to mitigate. So that's the first part of it. And people get it right away when I give them the story of plane or I take water. I said this is glass of water on the table. There's no evidence that it's poisonous. Mhm. Would you drink it? There's no evidence. Spook me. There's no evidence that. So, but when you tell him, hey, you know, you should worry about GMOs. He says there's no evidence they're harmful. Yeah, but there's no evidence that they're not harmful. Okay. So the asymmetry where you put the burden of uh of the asymmetry on that's a precious principle.
Finally let's hear from Navar Vicant how the erodicity principle applies to ethics and modern business. The Kelly criterion is a very popularized mathematical formulation of a simple concept. And the simple concept is don't risk everything. Stay out of jail. Don't bet everything on one big gamble. Just be very careful how much you bet each time so you don't lose the whole kitty. Nasim Taleb famously talks about erodicity which is a fancy word for the simple concept that what is true for 100 people on average isn't the same as one person averaging that same thing 100 times. The easiest way to see that is by playing Russian roulette. Six people who play Russian roulette once each and then each winner gets a billion dollars. One person ends up dead. Five people have a billion dollars versus one person who plays Russian roulette with the same one gun six times is never going to end up a billionaire is going to end up worth zero. And so risk-taking, especially when the averages are calculated across large populations, is not always rational. The Kelly criterion helps you avoid ruin. The number one way in which people get ruined in modern business is not by betting too much, but it's by cutting corners and doing unethical things or downright illegal things. Ending up in an orange jumpsuit in prison or having a reputation ruined is the same as getting wiped to zero. So never do those things. Lose money for the firm and I will be understanding. Lose a shred of reputation for the firm and I will be ruthless. I welcome your questions. Thanks for watching.
And before you leave, I want to share with you my latest open-source project. It all started when Jim Oanes said that all the knowledge to become a successful entrepreneur is now on the internet and it's free. And since I've been researching and learning from world-class entrepreneurs for the past 5 years, I had this idea of curating in a single place the top 1% of free digital resources that have probably constituted 95% of my understanding of entrepreneurship and business. But there was a problem. A, I'm not a developer. B, site builders like Wix or Squarespace are too basic to handle it. And C, web agencies would probably charge me thousands of dollars and take a couple of months to complete it. So the project stayed as just an idea. But now, eight months later, everything has changed. I found out about this new AI startup, Hey Boss, backed by OpenAI and also the sponsor of today's video. Hey Boss recently launched Boss Mode, giving every entrepreneur a full service AI team to build a revenue ready website fully customized to their business. So for my project, I first explained my idea to Astra, the world's first AICO, and then we chat about strategic decisions. Astra was really curious and she wanted to know things like what made my brand unique and which was the target audience so that the website's design and content can then reflect these choices. This took me about 8 minutes. Then the AICO explained the project requirements to the AI employees and they started chatting on autopilot while building the site. After 10 minutes, the site was business ready. But I still needed to add my list of resources for each category. So I share it with the AI team and they added it to the respective categories. After that, I told the AI I wanted to change the description and colors of each category. And finally, I made some quick edits myself to refine the site. You can check out this project at funerresum.com. A good business always thrives with a good website. After all, your website is the face of your brand. If you want to build your own, use my link below and enter the invite code nuggets to get exclusive access to boss mode.