Nassim Taleb has worked hard to popularize the concept of “skin in the game,” both through his books (like, well, Skin in the Game), and by calling people who don’t have sufficient skin in the game imbeciles on Twitter. The idea is straightforward: if someone makes a prediction, it doesn’t mean anything if they don’t have a financial stake in the outcome. In fact, it’s a negative signal: if you say X will happen, and you don’t bet that X will happen, you’re saying X is the kind of thing people want to happen, which is a decent signal that it won’t happen after all.
Taleb is an invigorating writer — his prose lands like a punch to the jaw — and he makes a good case, so after reading Skin in the Game, I decided to deliberately raise my risk. I’m a fan of calibrating tradeoffs by working backwards from expected costs, so I picked a goal: I’m comfortable with risking a 50% drawdown in liquid net worth, so I should design my bets so I’m risking around half my money in a worst-case scenario.
This sounded great in theory, but I started thinking about real-world consequences. It’s not just a number. If I actually lost a ton of money, I’d have to stop eating at restaurants. I wouldn’t be able to buy every single remotely interesting book. I’d have to consider… living in Jersey. (Due to hyperbolic discounting, I feel more dread about the couple days of moving than the far greater number of days that would be taken up by incremental commuting time.)
As it turns out, an investor who is also supporting a family without a fortune saved up already has plenty of skin in the game. The rigorous way to calculate how much leverage I have is to add up the net present value of my future expenses with my current lifestyle, and to add up the net present value of my expected wages, discount both back to the future, and figure out what kind of leverage my economic balance sheet has, then do a drawdown and liquidity analysis to ensure that I’m not thrown off by any short-term bumps in either cost or comp.
In other words, the rigorous thing to do is to make up a bunch of numbers. I just picked a lower tolerable drawdown. It’s theoretically less viable, but if you take a 95%-trustworthy process with fifty steps, the net trustworthiness is 0.95⁵⁰, or about 8%. So instead of making up lots of numbers, I just made up one.
It made me wonder, though: how much financial skin in the game does Taleb really have? Financially, it seems like he’s set: he worked as a trader for a long time, at banks and independently. He co-founded one hedge fund and has worked with a few more, although it’s unclear in what capacity. Taleb retired from active trading in 2005, and I have to assume he has enough money to keep himself well-supplied with squid ink and squat racks. And that ignores the book royalties, courses, and the like.
His actual net worth, and quantifiable skin in the game — these are none of my business. I’m just calibrating how seriously to take the ideas. Taleb is under no obligation to use so much financial leverage that he could actually go broke from his bets. He’s also under no obligation to do the much more fun economic equivalent of ramping up his spending until it vastly exceeds all the teaching fees and royalties, such that the only thing that can save him is a judiciously timed VIX bet. I’m just saying, he’d have more skin in the game, and Skin in the Game would be more credible, if he started dropping Chases at the club.
The Rich Are Different
If you can make one heap of all your winnings
And risk it on one turn of pitch-and-toss,
And lose, and start again at your beginnings
And never breathe a word about your loss;
— Rudyard Kipling, If
Y Combinator’s application used to ask: if someone were to offer to buy your company in three months, what’s the least you’d accept? It seems to have been dropped from more recent applications, probably because it’s useful information to have but a pointless question to ask. People react very differently to the theoretical prospect of money than to an actual check. There are many things you can say you wouldn’t do for a million dollars that you would, in fact, do if someone offered you a million dollars right now.
Money is motivating, especially when you don’t have much, but money doesn’t buy happiness. ln(money) does. As far as Science can tell, there is no point at which more money results in less happiness, it just results in less and less happiness at the margin.
Rationally, you’d expect very rich people to be somewhat risk-averse; doubling your money benefits you less than losing half of it harms you. And if you look at how dynastic fortunes get invested, they are indeed very risk-averse. If you’re a money manager whose job is to maximize the net worths of the great-grandchildren of your client, you have only one real job: avoid a catastrophic loss. Job number-two, by a long margin, is to compound the fortune at a rate faster than the family grows. If the million is an accomplishment and the tenth is just a number, at some point the rich should get bored.
So we have two forces: one is that as you get richer, getting richer is less motivating. The other is that, as you get richer, getting poor is less of a risk.
There’s a third force that pushes the rich in a risk-averse direction, though: status. Being rich is better than being poor, but it does have drawbacks. One is that it’s very hard to make non-rich friends. A really wealthy person — Forbes 400-level, say — could give away enough money to let an average person maintain their lifestyle without ever working or worrying again, and not notice it. Median household income in the US is about $56k, which is the tax-free yield you’d get on a portfolio of $2.4m in municipal bonds. A billionaire wouldn’t exactly feel the lifestyle difference from a 0.24% hit to their net worth.
It’s not impossible to have a healthy relationship across a huge net worth gap, just not trivial. Whereas if you’re a billionaire, and you meet some other billionaire, at least the two of you know you’re equally likely to rip one another off. Ironically, one category of relationship a really rich person can have with a relatively poor person that’s uncomplicated by money is an employer/employee relationship. The founder of a tech company generally has a net worth an order of magnitude or two higher than their direct reports, but the money doesn’t make things weird because the money nature of the relationship is established from the start.
This means that billionaires who take large financial risks aren’t just risking money. They’re risking their friendships. And friendship is both a powerful motivator and a worthy one.
Which raises the question: why do rich people take giant risks sometimes? If you run a big-enough, profitable-enough company, why risk everything levering up to buy your biggest competitor? You could lose your fortune, and which might cost you friendships — relatively shallow ones, sure, but friendships you value.
One possibility is that rich people want to use the money — that there’s something they want to have that happens to cost billions of dollars. Unlikely. It’s not feasible to consume billions of dollars, unless you extend that consumption to include things like charity. And while charity is a nice thing to do, it doesn’t tend to be especially goal-oriented. The Gates Foundation spawned dozens of news stories when they actually measured the effectiveness of a program and shut it down because it didn’t work. There are lots of headlines about big charitable donations, but the headlines about big charitable outcomes are a) rarer, and b) once again mostly the Gates Foundation.
My theory is that rich people are just weirder than the rest of us. Some people have odd obsessions, and don’t seem to feel the declining marginal utility the way the rest of us do. Lots of people work out and are happy with their lifts, but Hafþór Júlíus Björnsson is probably kind of depressed about his. The only way to squat 970 pounds is to get your squat up to 965 and decide that’s inadequate. Some people really enjoy their one vacation a year, some people feel like visiting a hundred countries just means you haven’t spent a single day in half the countries on earth. And to some people, the really cool thing about having a billion dollars is that all you have to do to be a decabillionare is earn a thousand percent on your money.
Lots of Skin in the Long Game
Taleb is a fun writer, and he’s done a great job articulating a philosophy. But when your philosophy is all about action over talk, the person who’s best at explaining it is almost guaranteed not to be the best exemplar. Hardly the first time. Nietzsche didn’t exactly look like an ubermensch, and Machiavelli was in maybe the 20th percentile of Machiavellian-ness in Renaissance Florence.
But it does raise an interesting question: how much can you learn from someone who’s better at articulating than at acting? Someone like Taleb (or Machiavelli, but definitely not Nietzsche), who was a practitioner turned philosopher, might be the best middle ground. Someone who is truly focused on making money won’t tell you exactly how they do it, because that’s giving away valuable intelligence to the competition. Someone who tries to be an expert but hasn’t actually accomplished anything in the field is obviously totally worth ignoring. The in-between thinkers give you ideas that have been tested in the real world, and that you can try to fit to reality — but the theories are necessarily imperfect.
When you read a theoretical book from a practitioner, the exercise you want to do is this: start with the theory, then ask “If someone believed approximately this, what would they do differently if, instead of writing a book about their field, they’d been a whole lot more successful in it?”
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 What is a worst-case scenario? My answer is: your biggest asset exposure goes down more than it went down in 2008 (assuming it went down in 2008; pick a different crisis if you mostly own gold and treasuries), and all correlations go to 1. For a vanilla equities/bonds portfolio, you can’t get to a 50% drawdown without leverage, unless you assume your country loses a war.
 Here’s why: for most of your life, your biggest asset will be the net present value of your future income. It’s an equity-like asset: variable cash flows that generally rise over time, eventually peak, and then decline. Your biggest liability is your expected future spending. Since most people spent a fairly large percentage of what they earn, and we tend to spend more early in life and make it up with savings later, the built-in leverage is quite high.
For example, I put together a simple toy model: assume someone starts out earning $30k/year and spending 110% of what they earn, and each year their spending as a percentage of income declines one percent. Assume 3% annual raises and a 40-year career, and discount everything back to the present with an 8% discount rate. You get a net present value of future income of $510k, a future spending liability of $492k, equity of $18k, and thus leverage of 28.3:1.
 I suspect that one of the reasons bribes happen is that your brain is totally short-circuited by seeing a life-changing sum of cash, so you say “Yes” without thinking and then, even if you regret what you did, you’re more likely to cover it up out of shame than to come clean. The power of a bribe is not paying someone to do what you want, it’s being able to blackmail them because you know they took a bribe.
 Michael Lewis is an amazing case study here, since he’s turned a few years of industry experience into a few decades of writing. My theory for why he made it as a writer and didn’t make it as a bond guy is that he really wants to be sold to. When he hears one side of a story, he wants to tweak it, burnish it, perfect it, and share it. That’s a great trait for writing books that oversimplify changes in market microstructure or the financial crisis, but it’s perhaps the most damaging possible character flaw for someone who actually trades. If you reread Liar’s Poker through this lens, you’ll see that Lewis constantly makes the mistake of hearing just the bull or bear thesis and thinking it’s the only thesis. Good on him for turning that liability into an asset.