Episode 21 – How to Avoid the Fat Tail Risks In Retirement

Remember when the IRA used to say to Margaret Thatcher that she had to be successful 100% of the time but they just needed to be lucky once?

If they got lucky just ONE TIME, and were able to assassinate her, the whole world might have been a different place. Or if John Hinckley were a better shot, Reagan may not have lived and what would have happened then?

What’s the point of this, you might be asking? Simple.  If an unlikely incident happens that destroys you, even if the odds against that happening were huge, it’s a FAT TAIL RISK.  The consequences of such an incident happening are so enormous that the risk to you needs to be judged differently than any other types of risk.


Nassim gives us the widely-used fallacy that terrorism is just as risky as falling off a ladder.  In terms of past occurrences, this is correct.  The amount of people falling off ladders and being hurt in terrorism is similar.  But that is not the end of the story.

If a terrorist gets lucky, and is able to detonate a dirty bomb in Chicago, that risk is profoundly greater than the risk of one more person falling off a ladder. Even if a terrorist has previoiusly been unable to detonate a dirty bomb in Chicago, that does not mean the risk has been reduced.

Also, if you are worried about falling off a ladder, the answer to avoid that risk is simple, don’t climb up a ladder.

But to compare the two in terms of risk is absurd. Unfortunately, these things happen all the time.

In this episode, I argue the same can be said for retirement planning. So many retirement projections are based by using previous U.S. market performance and extrapolating that into the future.  Even Monte Carlo analysis is guilty of this.

Yes, the Monte Carlo has a random sequence of events. Meaning, 2008 could be followed by 1974 etc, and that potentially could be devastating to that unlucky person who retired into those back-to-back years.

But, that’s just one scenario out of 10,000 using return numbers that were simply phenomenal in the history of the world.    In fact, the world has never seen investments returns like that of the US over the last 100 years…ever.

So, to use that for future analysis seems to be quite a bit of cherry picking.  Doesn’t mean it won’t happen but let’s think about this.

How much different would your retirement projections look if we used the world average investment returns over the last 100 years as opposed to the US? What would you do differently going forward?

And here is why I harp so much on paying down debt.  That is the ONE thing you can control.  Paying down debt is the safest, most assured way to increase your net worth and reduce your outgoing cash flow.   Nothing else even comes close.

So, pay down your debt in order to eliminate the fat tail risks that could destroy you financially. You’re always going to need a place to live.  Have a home with no mortgage still has risks, don’t get me wrong, but not anything to the extent of the US having an investment scenario like that of Japan over the last 30 years, or China in the 195os.  Or Germany in the 1920s. Or Russia, or Venezuela or….

Pay down debt, my friends.



Visit Nassim Nicholas Taleb’s website here. Directly from Nassim Nicholas Taleb:

Another Pinker statistical fallacy, which can teach students how NOT to look at risks and mix random variables of different (tail) properties, or confuse types of estimators. This afternoon, to kill time on a long flight I decided to look for scientistojournalistic fallacies so I went to Steven Pinker’s twitter account. I immediately found one there. (Heuristic: go to Pinker). He promotes there a WSJ article to the effect that “Terrorism kills far fewer people than falls from ladders”; the article was written by a war correspondant, Ted Koppel and is very similar to his Angels thesis.
Now let’s try a bullshit-detecting probabilistic reasoning.

A- Falls from ladder are thin-tailed, and the estimate based on past observations should hold for the next year with an astonishing accuracy. They are subjected to strong bounds, etc. It is “impossible” to have, say, >1% of a country’s population dying from falls from ladders the same year. The chances are less than 1 in several trillion trillion trillion years. Hence a journalistic statement about risk converges to the scientific statement.

B- Terrorism is fat tailed. Your estimation from past data has monstrous errors. A record of the people who died last few years has very very little predictive powers of how many will die the next year, and is biased downward. One biological event can decimate the population.
May be “reasonable” to claim that terrorism is overhyped, that our liberty is more valuable, etc. I believe so. But the comparison here is a fallacy and sloppy thinking is dangerous. (Worse, Koppel compares terrorism today to terrorism 100 years ago when a terrorist could inflict very limited harm.)

Song of the Day: Ted Nugent and the Amboy Dukes “Great White Buffalo”

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