6 min read

Financial fragility

Financial fragility

Imagine there's a cup of coffee on the table nearest to you.

When you stand up your leg might catch the table and knock the whole thing over. The coffee cup isn’t going to like it. You're not going to like it either.

You’ve got coffee everywhere and the cup has been smashed into little pieces. Sad!


Nassim Taleb talks about things falling into three classes:

  1. Fragile. Things damaged or completely broken by shocks
  2. Robust. Things that resist shocks, or stay the same
  3. Antifragile. Things that gain from shocks

Some quick examples:

A coffee cup is obviously fragile to shocks.

A wooden bowl is robust to similar shocks.

The human body is fragile, robust, and in some ways, antifragile.

For example, if you lift heavy weights it stresses your body and your muscles repair themselves, becoming bigger and stronger. Similarly if you’re exposed to a small amount of bacteria, that’s healthy. 5 second rule.

Real risks for normal people

You’ll have heard the word ‘hedging’. Hedge funds. You hedge your bets. Big financial institutions and companies have hedging strategies which protects their money from certain outcomes.

We’re just normal people. We don’t have the time, energy or money to be worrying about sophisticated 'hedging' strategies. We've got work in the morning.

Big healthy savings and a well diversified portfolio built on a foundation of passive funds is probably as good as we can do.

An economic meltdown is just one risk that normal people face. But it's not really worth worrying about. You can't do much about it. Same goes for politics. All you can do is prepare.

Here are some real risks for normal people:

  • Job loss
  • Health problems
  • Relationship problems
  • Dietary risks
  • Family problems
  • Crossing the street and getting hit by a bus
  • Car could get scratched
  • Dropping your iPhone in the toilet

On top of these risks, there is another class of risk we face:

  • Unforeseeable risks

Unforeseeable risks are things we cannot even imagine. If we could, they wouldn't be unforeseeable. These risks can make us fragile.

It's worth thinking about the real risks you face. Not just random ones imposed on you by people you read and watch. The news is trying to be scary. Are there people who go to bed at night and worry about North Korea's nuclear abilities?

There's more immediate concerns.

Think about what could happen in your life that would put you in a very weak position. Build up your robustness in that area.

Inflation and being over invested

Warren Buffett has a saying:

"Rule one: Never lose money. Rule two: Never forget rule one."

People on the internet talk about inflation a lot. Inflation is a real risk of holding cash. People encourage others to put money into investments to combat it.

It is of course, true. Inflation erodes your money over time.

But inflation is another one of these overhyped financey buzzwords like 'hedging'.

It's important to know about in a wider sense of being financially literate, but it's only really a small risk for normal people. It's not really something we can do much about.

A much bigger concern is being over invested. If an unexpected cost crops up, being over invested could be a problem.

Let’s go over this with an example, because it's important.

Say you have £10,000 to your name.

You invest £8,000 and decide to keep £2,000 held back as your emergency savings. Then a person on the internet tells you you’re an idiot for holding your money as cash. You feel stupid because this person is so adamant you're an idiot.

You think, “damn, I don’t want to be one of those idiots who lets their cash get devalued by inflation” so you throw your £2,000 emergency fund into investments too. Maybe you even sign up to that person's course/book/class/conference.

Then, an unforeseen cost slaps you in the face. It could be an emergency dentist appointment, or maybe you're made redundant after following some advice from Naval, like "delete emails without responding or flinching".

So now you've lost your job, and you have costs to cover. Are you going to be okay, or will you have to sell your investments?

Your investments are down, and you could make a loss if you sell. You're also going to disrupt the compounding that's working hard for you if you sell. You decide to hold off. You think you'll be okay for now...

You hold off, things get tighter, the market dips lower.

Now you really need the money and have no choice.

You sell your investments. At a loss. Your wife divorces you, you have legal costs to cover, you move into a flat on your own, you have to eat super noodles for the rest of your li---

Remember rule one?

This isn’t me being negative this is just real life.

How many people do you know who struggle with their wealth being eroded by inflation?

And how many people do you know who have struggled after being made redundant?

People don't talk about using your 9 to 5 to mitigate the damaging impacts of job loss. They talk about investing and trying to make money with money, because they're incentivised to do that.

"I can show you how to make make money" is much more exciting than "build up a large pot of savings from your salary in case you get fired".

Again, big healthy savings and a well diversified portfolio built on a foundation of passive funds is probably as good as we can do. Even better, building other sources of income to make you less reliant on one job. Two incomes of £5,000 from two sources are better than one income of £10,000 from one source.

If you gave the human body to some of these grifters, they'd sell off one of your lungs because "you can breathe just fine with one." They'd be like "selling a lung can get you enough money to start your trading career".

Be careful with advice. Be real about your risks. Only you have your best interests at heart.

Becoming robust

So, how do you avoid becoming another average investor who makes terrible returns.

A good start is to try and make your whole financial infrastructure more robust.

To recap. You're financially fragile if:

  • You’re in debt
  • You’ve got no savings
  • The money you do have is tied up in something
  • Your investments are too risky (you’re all in a few stocks, or lots in crypto)
  • You’re solely reliant on your employer paying you your salary

To have robust finances, you need to invert these bad things. That might look like this:

  • No debt
  • Big savings (3-6 months expenses minimum, imagine 12+ months!)
  • The money you’re investing uses the barbell (most of your money is relatively 'safe', and a small portion is in high risk/payoff investments)
  • You’re not overexposed to anything (e.g. all in a few tech stocks)
  • You can get money from places other than your employer

We can do the first 4 out of 5 easily enough. Creating another income involves transitioning to a whole new mode. We can do that too, it's just hard.

We need to put ourselves in a position where we can make lemonade when life gives us lemons.

Becoming antifragile

If you’re employed for life you’re fragile for life.

To remind ourselves, antifragility is about gaining from shocks.

You can’t really gain from a shock when you’re employed.

If the business you work for strikes a rich vein of profitability, you might at best receive a bonus, but ultimately even if revenue increases by 600%, your salary isn't going to move much.

How can we become antifragile as individuals?

You guessed it. You need to have a go at building your own lemonade stand.