Earlier this week I wrote about the new book from Steve Magness and Brad Stulberg and focused on one topic: balance. As Stuart McMillan pointed out on twitter, the word balance can be misleading as it doesn’t always capture the undulating-dynamic nature of anything. It’s true. When you think of balance, you think of something that doesn’t move or you think of taking the middle of the road approach. But balance can come in many forms. Thinking of the middle of the road ignores the dynamic nature of balance; all we get from the middle of the road approach is often just an artificial sense of balance.
Balance and Investing
I see an example of this problem every day in my day job at a bank. The holy grail for investment managers is to create a portfolio with a high rate of return and no risk. In other words, huge upside but no downside. Unfortunately, such a portfolio does not exist. Instead you have options that range from low risk and low reward (e.g. cash) to high risk and high reward (e.g. speculative leveraged trading). In the middle is what is called the “balanced portfolio” which tries to balance risk and return. To do this, assets are normally allocated among different asset classes (cash, fixed income, equities, etc.), sectors, and geographic areas in order to spread out and minimize risk while maintaining some upside potential.
In his book The Black Swan: The Impact of the Highly Improbable, Nassim Nicholas Taleb explains how this middle of the road approach just gives you an artificial sense of balance. While you might think you have a balance of risk and reward, you don’t. Just think of the best and worst case scenarios. If the market does well, you are spread so thin to truly benefit from it and might be lucky to see a 10% gain in one year. If the market crashes you could still lose half of your money.A balanced approach doesn't mean taking the middle road. It often means living at the extremes. Click To Tweet
What a “balanced” portfolio really offers you is limited upside with a large downside. We try to convince ourselves that the downside will only come in rare events, but, as the markets keep showing us, bad things happen more often than we would think they will. You might have diversified from one nest egg to several, but when all the eggs are in one basket you are still screwed when you drop it.
The Barbell Strategy
The true balanced approach is not the in middle, but in the extremes. Taleb offers a counterexample if you truly want to reach the goals that a “balanced” approach aims for. Rather than having multiple eggs in the same basket, you put your eggs in two baskets. In the one hand you hold 90% of assets in hyperconservative investments (e.g. cash). In the other hand you invest the remaining 10% in hyperaggressive products such as options.
What is the best and worst case scenario here? If the market crashes you lose, at most, 10%. That is nothing to laugh at, but you are not living on the street. But if just one of the speculative investments works, you are in for a huge gain. The result is that you have a small downside and big upside. This is the type of balance we really want. It is balance not in the sense that there is equal amount on each side of the barbell, but in the sense that it is a strategy to respond to the complex unknown situations we will encounter. It is a way to weather the storm and come out stronger.
Taking the Barbell Back to Sports
The barbell strategy is named after sports, so it only makes sense to bring it back to its roots. John Kiely and I discussed the barbell strategy in our seminar last week as an example of how balance is not about staying in the middle. Balance is a key concept in periodization and planning but that doesn’t mean we just do lots of medium intensity work. Polarized training has been a huge discussion point over the last decade thanks to the work of Stephen Seiler. The concept is nothing new – Bill Bowerman was using a hard-easy method for marathon training a half century ago – but it is an applied version of barbell training. You have a small does of speculative work (high speed training) and a large does of safe work (low speed training). You find balance by poking around at each end of the spectrum.Ideal training sets a guaranteed floor but leaves a maximal upside. @bingisser Click To Tweet
The barbell strategy can also be applied to the use of variation in training. As we discussed on a recent GAINcast, the paradox of change means that drastic change drives adaptation, but it also increases the risk of injury. How do you manage that paradox? The barbell strategy can help. Simply keep 90% of your training in safe investments (the basics, things you are familiar with, what you know works, etc.) and try a bunch of new things with the remaining 10%. If just one of them works, you are in line for a big personal best, but your downside is also limited as meat and potatoes still make up most of what you are doing. On the other hand the middle of the road approach (e.g. a 5% volume increase across the board) will likely be too little variation to spur adaptation, but at the same time will still increase the risk of overtraining and injury.
Taleb himself lifts weights regularly and has even written about the topic on occasion. He also sees no value in the middle of the road approach:
“Just as systems learn from extremes, and for preparedness, calibrate themselves to withstand large shocks, so does the human body. Indeed, our body should be seen a risk management system meant to handle our environment, paying more attention to extremes than ordinary events, and disproportionally learning from these.
You will never get an idea of the strength of a bridge by driving several hundred cars on it, making sure they are all of different colors and makes, which would correspond to representative traffic. No, an engineer would subject it instead to a few multi-ton vehicles. You may not thus map all the risks, as heavy trucks will not show material fatigue, but you can get a solid picture of the overall safety.”
Will I stop using the word balance? Likely not. But I will continue to make sure people understand the complexity of balance. If you don’t understand what balance really is, chasing it will put you down the wrong path.