Dynamic versus static risk management, part 2
Now let's build a frame which is inherently antifragile
In our previous article we highlighted the distinction between ‘set it and forget it’ approaches to risk (static), and ‘decisions in real time’ approaches (dynamic).
We can now build a bigger frame to think about how to benefit from this distinction. First we’ll build the frame, then we’ll consider some actual examples. Let’s build a frame which is inherently antifragile, and thus inherently positioned both to hunt positive black swans, and avoid negative black swans:
Step 1: Be the creator, not the consumer. We might alternatively say, ‘own the platform’. Be the one providing responsibility and value. Be an actor, a player, rather than a spectator. The distinction is significant, and actually relates to risk. The creator takes obvious risks; what you create may fail,and fail visibly; this is why people would rather consume than create. However, the consumer takes hidden risks over the long term, risks over which they have little control (or even awareness). For instance, an overweight man training in a gym or getting started in running takes a certain risk; he may struggle, experience real pain and discouragement, and he may be mocked by others. But as months become years of training, each micro-risk (each training session) serves to pay him back well. And all those who never did any exercise, but chose to watch others exercise on TV and sport, nurtured all kinds of hidden ailments and diseases. So on the long-term, it’s better to be the one taking known, frequent risks, rather than the one accumulating hidden risk without even knowing about it.
Step 2: Know that you don’t know. This is more than intellectual agreement with the reality that there are things you don’t know. This is making ‘what you don’t know’ your primary focus. Turn black swans into ‘grey swans’, argues Nassim Taleb in his paradigm-changing book The Black Swan. How do we do this? By doing our best to identify all the possible outcomes we can think of, especially the negative events and the catastrophes. The point is, build on the basis of your un-knowledge, your lack of control; rather than planning on the basis of your knowledge, the mirage of your control. A sudden market downturn when you’ve had money in, say, oil, is not a black swan but a grey swan. You knew it could happen; the question is whether or not you had spent any time considering and making preparations for such an eventuality. So, dynamic risk management starts with actually taking risks (step 1), and then builds on top of that with the foundation of what you don’t know.
Step 3: Know how to execute and respond in real time. This step is where the magic really happens, but it has to be built upon steps 1 and 2. This is where we make the transition from know what to know how. Step 3 is not necessarily that hard, provided you’ve done step 2 carefully. For instance, if you have dived in with an investment and there’s a sudden move on stock price, you may find yourself panicked as to what to do. But if you’d thought through the possibility of a sudden unexpected stock move, in step 2, you’d have written up a simple plan for how to respond if it ever happened. As an antifragile parent, step 2 is where you accept the reality of tantrums and disciplinary nightmares coming at worst possible moments, but this leads you to make simple contingency plans for if and when they happen. As we discussed in our previous article, you can have the best strategy on paper, but if you can’t execute in real time it’s valueless. You may have an investment portfolio with holdings that are massively increasing in value, but if you don’t know when precisely to buy and sell, you may well wait too long, and then end up with far less cash in hand.
There’s a final step to this framework, which we’ll come to in the third part of this series. We’ll follow that with a long list of examples and different domains to show what an antifragile, dynamic risk management strategy looks like in different areas of life.