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IFB134: Skin in the Game Book Review

Announcer:                        00:00                     You’re tuned in to the Investing for Beginners podcast. Finally, step by step premium investment guidance for beginners led by Andrew Sather and Dave Ahern. To decode industry jargon, silence crippling confusion and help you overcome emotions by looking at the numbers, your path to financial freedom starts now.

New Speaker:                   00:35                     All right folks welcome to Investing for Beginners podcast episode 134 tonight we’re going to do a book review. I’m going to talk about it, a book that I read recently and we’ll kind of go over some notes that I took on the book and Andrew and I will talk a little bit about it. So the name of the book is called Skin in the Game. Nassim Tabel wrote it. Now, if you have not read any of his books, this is his fifth installment of the Incerto series. So he’s also written, saw other fantastic books like a Black Swan Antifragile as skin in the game as it is a most recent one. That’s the one that I’ve read. I have not read the other four yet. Andrew, have you read any of his books?

Andrew:                              01:18                     I’ve done some of Black Swan [inaudible]. He’s like a fascinating guy’s got a lot of great ideas. People Revere him because when he wrote Black Swan, I think it was right before either the 2010 flash crash or the 2008, 2009 bear market. But the gist of it is that people try to reduce risk in the market and, but they’re investing, but they don’t think of what it is called, like a Sigma six-event or something. They don’t think of that Black Swan. The unprecedented event that we’ve never seen. And all it takes is that to wipe out all the other smarts and gains that you’ve had. And you know, the timing of that book was great. The theories in the book and everything like that is really good. And that’s something that, especially, I think as the internet goes on and on and on, and I’ll stop going on and on and on about it.

Andrew:                              02:21                     But you know, as we get more educated than people know more about investing, we tend to take kind of these mental shortcuts and think that, Hey, this is the way to reduce risks, but if we’re not defining risks in the right way, then we’re not reducing risk against something that could happen that we’ve never seen. And so, you know, his, it’s an idea that kind of flips the idea of risks on its head. And it’s profound and it’s true. And so, you know, that’s, I know that book had a lot of critical acclaims. I think Anti-fragile did too.

Dave:                                    03:00                     And yeah, I wish I had it. It’s, they’re tough reads, man, like he [inaudible] academic, but at the same time it’s, it’s fascinating. Yeah, it is. It’s, it’s not a Game of Thrones, you know, thrilling, super easy to read kinds of books. The other, they’re very, they’re very dense. I think that’s what I heard somebody say about them. They’re very dense. Yeah. He’s incredibly intelligent and he’s probably considered one of the smarter thinkers out there right now. And he’s very eloquent. He’s very educated; he’s also extremely opinionated. And if you want a, a great person to follow on Twitter, that’s always entertaining. He would be a must-read if you will. So let’s talk a little bit about the games or the game the book skin in the game. So what is Skin in the Game about?

Dave:                                    03:57                     Let’s, let’s think about this. So let’s consider two people kind of use an example. So what I’m going to do is I’m going to pull out some different examples that he used through the book. So the first example is as a banker who is selling questionable mortgage back securities, so-called credit default swaps, he knows that the securities we do demic rest, which may cause them to blow up. In the case of a backs Black Swan event, which Andrew was talking about, whoever he and his employer making a good box for in speculating in these securities. And by the way, if they were to blow up in a case of an unexpected event, the bank would probably expect to bail out anyways. So consider person number two. Person number two is a pilot. He works for an airline. He does, he makes pretty good money and his work revolves around taking people from point a to point B most safely and quickly possible.

Dave:                                    04:42                     He knows, however, that if anything were to happen to his customers, I. E. the passengers, he would go down with them as well. So skin in the game is really about symmetry. If you’re able to reap the benefits of a positive outcome, you also must pay the harm or the penalty if something goes wrong. So the wrist shouldn’t be able to be possible to transfer to others. So who’s got skimming the game in our first two examples? It’s pretty obvious. It’s a; the banker does not have skin in the game. It’s the pilot cause if the pilot goes down if you know everybody that he’s transporting dies in a plane crash, which would be horrible, obviously the pilot’s also going to die as well. Whereas the banker, in our scenario, is not going to lose anything because the bank would take the blame, and he would be able to transfer the risk to the government or the taxpayers like us and they would be able to bail out his mistakes.

Dave:                                    05:37                     So he doesn’t have ahead in the game till he refers to this kind of like the head. The bankers win tales. Someone else loses a; he calls it the Bob Rubin trade. So skin in the game is the Tector; it allows you to judge the reliability of knowledge and or certain advice. It’s also about human affairs. So those who do not take risks should never be involved in making decisions. So I think that’s pretty obvious when you think about skin in the game involves having something, you know, at risk when you do anything, whether it’s investing, whether it’s, you know, asking a girl out on a date, whether it’s, you know, deciding not to study for a test, you know, you’re going to be the one that’s going to quote-unquote pay the price if things go sideways.

Dave:                                    06:29                     All right. So let’s talk about a little bit some implications of skin in the game. So let’s talk about like a minority, how it rules over the majority and how it can make you smarter and how it can turn employees into, as he calls it, obedient dogs. Have you ever thought about why peanuts are not allowed on airplanes? Perhaps why TV series sometimes end up getting banned because of some ethnic sorts slur or perhaps why dietary advice such as veganism has such an impact? It’s all due to the minority rule. It comes from the skin in the game. When there’s a minority that can’t compromise, the flexible majority will adapt to the preferences of the minority. For example, a person who has orchard to peanuts won’t board a plane with peanuts on it. A person who isn’t origin from peanuts, on the other hand, can board a plane filled with peanuts, but he doesn’t mind boarding one, which is peanut-free.

Dave:                                    07:24                     Either. Put the most intolerant wins. So, the person that is allergic to peanuts cannot get on the plane. So if they want people to fly in a plane, they have to make the planes. Peanut freight kind of makes sense imagines the stubborn daughter who manages to convince her whole family into eating vegan food only because of some environmental ethical or fictional slash fictional quote-unquote health-related reasons. Now imagine this family going to a barbecue, the organizers, the barbecue and know of the preferences of this family. So they are left with two options, cooking two separate dishes or cooking a single vegan meal. The path of least resistance is obviously to cook vegan. Now even the supermarket in the neighborhood must supply the increase of vegan food to meet the needs of the minority. To see how the most Dubberly minority was able to convince the not so stubborn majority in society.

Dave:                                    08:23                     This only requires a small level of such stubborn minorities, say 3% to impose their purposes on the majority to leave tells a story of how hopeless it was for him to learn about probability. It’s statistics in school. As soon as he got his first position as a trader, though, he suddenly had skin in the game and this made all the difference unexpectedly. Everything seemed clear. How come he didn’t understand that before? Because he added skin in the game, which makes you smarter and makes you have to pay attention and decide to figure out what it is you need. Know. All right, so let’s talk about financial statements for reading and for sure is boring can be is it hard? No, it’s not. But it does take some morning. So analyzing the profits, liabilities, the cashflow as a company sometimes can not be all that interesting, but it is a necessary necessity to becoming a great longterm investor.

Dave:                                    09:16                     And once you have skin in the game, there’s a lot of money on the line. So the activity becomes anything about mundane. So let’s think about some of the heroes that we’ve talked about. Warren Buffet for example, talks about how he reads five hours a day at least, or 500 pages a day. I believe it is. Is that right? 500 pages. I thought it was five hours, but it’s probably about, it’s probably about you know, darn well he’s reading a lot of 10 K’s, a lot of financial statements. And for him, it’s exciting because he has skin in the game. He has money on the line when he ends investing. Andrew I the same as the same way for us. I mean, we’re geeks, so we like it. It’s interesting to us, but we also have skin in the game, you know, when, you know, we’re saving money for our retirement. A big reason why we read these is that we have skin in the game. We want to know what’s going on. So for me,

Andrew:                              10:06                     I remember starting as a, as a beginner, and I don’t know if anybody’s ever picked up on this, but some, you know, places or people or websites will recommend that you know, maybe you should start paper trading and, and, and you know, basically the idea of paper training is you would write down a stock ticker and you would write down, Hey, I would’ve bought this here. And then you kind of track it over time. I had tried doing that when I first started investing and it never really made anything click for me. And it wasn’t until I bought my first share of stock is when something, something flip or now all of a sudden I was very interested in it. I was able to pick up a lot of knowledge quickly and just really got immersed in it right away.

Andrew:                              10:57                     And I think that’s an example of skin in the game. And the reason why a lot of the time I always try to recommend, Hey, if you can buy a share of stock as soon as possible, don’t try to overthink like, like that. Buying your next stock is going to be this huge event and it needs to be so carefully planned out really. And now even with no commission trades, you can, you can buy one share, spend like five, 10, $15. Yeah. Get a share and, and know what it’s like to see that in your burgers account. Know what it’s like to see that balance fluctuating up and down and, and get in the habit of being immersed as an investor. And I think that’s a; it’s a far better way, than paper trading or doing anything of that sort when you’re first trying to get started. And that’s because once you have skin in the game, you really to pay attention.

Dave:                                    11:55                     I agree. And that’s the theme that, that he keeps coming back to over and over and over again in the book. And he uses, you know, countless examples of situations and ideas. And things that happen in a society with people that really kind of help illustrate skin in the game and how much of an impact it has on us. As you know, humans are we struggled to find motivation for different things. He believes that once you discover skin in the game and whatever aspect of it is, it will change your mindset and your thought pattern and, and your incentive to get better at it. Like Andrew was talking about with investing, once he had skin in the game, I E. His money, it became a lot more interesting to him. The same thing happened to me exactly the same thing.

Dave:                                    12:48                     I, you know, I bought Microsoft just like Andrew did. And once I, once I pulled the trigger on that, then things got, you know, quote-unquote more real. And I wanted to learn as much as I could about what I was trying to do because it made sense. You know, I work hard for my money just like we all do. And I didn’t want to, you know, gamble it away because I didn’t know what it was that I was doing and it became far more interesting. All right, so moving on, there’s another takeaway that he had. It’s a; he refers to it as inequality versus inequality. So he’s talked about the importance of not resenting rich people. And if you want to be rich one day yourself, and he wants to ask us this question, what group of people would you strip off their riches if you could?

Dave:                                    13:39                     So if we could take money away from a group of people, which group would it be? So group a would be the entrepreneur, the musician, and the football pro group be, it would be the banker, the bureaucrat that she’s chief executives, people who wear a tie. So Andrew, which group do you think would it be that we would want to strip the money from? Well, I already know. First off what without having read the book, I already know which one he’s going to pick. Okay. It’s just like, so black and white. But yeah, you take away from the people who are part of the system and, and you want to give towards the people who create, yes. Yup. That’s exactly right. So what he said was the chances are that you’re going to tolerate the inequalities associated with a group but resent the rich people from group B.

Dave:                                    14:27                     Why is this a because the rich people of group B appear to be persons just like us, but the exception, they have probably played the system and acquire privileges that aren’t warranted for their positions. So if you had shown the studies in America are more prone to resent people who got rich from salaries rather than those fruits who earned it through entrepreneurial endeavors to leave suggests that what people resent, or at least what they should resent is individuals at the top without skin in the game. Consider the banker who earns a lot of money, but it’s very risky. That’s it. And when crap hits the fan, he calls black Swan and gets a bailout. Like, compare this to an entrepreneur who started in his mother’s basement, a coding software, no part-time job. His downside is all the hours he spent developing that sought for earned vain and have to stay in that basement of toys like 40 or something.

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Dave:                                    15:30                     So let’s talk about another, another Takeaway yet. So takeaway number four was ergo [inaudible]. So consider two different games. So gay main, the six people are invited to play Russian roulette. You get $1 million every time someone takes a shot and survives, and you’ll have to pay $3 million every time someone dies. The next day, six new people are invited. Group B, you’re invited to play a game of Russian roulette. The D was that you should take six shots every day. You get $1 million each time you pull the trigger and survive, but you’ll have to pay $3 million each time you put a hole through the back of your skull the next day or you’re invited to play again. The expected value of the two games are identical, three hundred and thirty-three thousand three hundred and thirty thousand dollars per shot, but there’s an important difference. The game involves the so-called a and sambal probability or in other words, the probability of a collective. While game B involves time, probability, or in other words, the probability is of a single person through time game a fulfills what to leave calls ergo [inaudible] for someone to be ergo, there could be an absorbing barrier, which means something irreversible and game a, you’ll be able to get the longterm returns of the game as every new day.

Dave:                                    16:44                     You’ll get six new people coming to play. Furthermore, during a single day, it doesn’t matter to a player of six players get five to bite the dust he can play anyways in game B and the other hand, that is not the case. If you manage to blow the preens out on your fifth try, there won’t be a six-try. Yeah. Okay. That’s a good point. In other words, you have an absorbing barrier. You can’t play the game any longer. Confusion arises regarding ergodic city because it may seem that since the one-off risk is reasonable and additional one-off after that is reasonable to at the roulette table. For example, it comes to us naturally that that is not the case. If we keep trying to double the money we’ve earned, we will eventually go broke and real life, it could be stealthy. Eating a bag of potato chips is bad if you do it once in a while, but doing a consistently every day for many years will make it so the fakes the risk of meeting an absorbing barrier through your death by cardiovascular disease or diabetes. Let’s apply your arrogance. Does it need to? Trading is trading with up before you always risking $2,000 in each bet and Erica Dixon’s strategy. No, it’s not. The issue is is that at some point, you’ll go bust using a strategy that’s an absorbing barrier. Once you hit $0 million in your account, you could no longer play the game unless you go outside of the game to find more money to start a new one. Of course. But that’s another story.

Andrew:                              18:05                     So, so let me, let me try to wrap my head around the first game that you mentioned that it’s all new people. Is it assuming that like let’s say it’s me, am I part of the game, but then I get to rotate with six fresh people? Does he have like a concrete example later on in the book about how that relates to a personal investor, or is he going on with the whole like banker thing again?

Dave:                                    18:36                     Yeah, he’s more talking about the banker at that point. He’s the way that I, the way that I understood it is that you have, you can keep playing until you hit a barrier that forces you to have to stop. And when you have skin in the game, you have a choice of which kind of game you want to keep playing. If you want to keep gambling and trying to one-up, one up, one up, one up, eventually, you’re going to hit a barrier where you can’t do it anymore. Whereas if you try to be less risk of firsts, you have a better chance of continuing to play for as long as you want to play. Okay. So the last takeaway that I wanted to talk about is how the investor can use the skin in the game. To his advantage. Skin in the game is of major importance for an investor to understand, not only do the passive investor who lets his or her money be managed by someone else, but also to the active investor who makes his own financial decisions.

Dave:                                    19:38                     Let’s examine how these two different skimming skin in the game for the passive investor. When it comes to financial advice, this is a good starting point. Don’t tell me what you think and tell me what’s in your portfolio. And sure there are differences, how risk-averse people are, what their financial situation looks like and so on, which may have affected an optimal portfolio. Should you look for each individual, but by knowing what your money manager truly believes in and using that as a foundation, how to construct your portfolio is always a good idea. This can also be considered when investing.

Dave:                                    20:13                     How could we manage our ships, make sure that the money manager has skin in the game or that he or she isn’t allowed to reap the benefits of the positive outcome, but has to pay the price in case of a negative outcome too. So a lot like what you’re doing.

Andrew:                              20:27                     Yeah. Yeah. A lot of it reminds me of one of the very early episodes we did was episode six, I think six things. In the financial industry, you won’t tell you. Yes. A lot of the conflicts of interest, we broke down and, and tried to describe in a, it sounds like, you know, he’s, he’s just confirming

Dave:                                    20:48                     That again and again. Yeah, yeah, exactly. You know the skin in the game is a, is a comment or a topic that I’ve heard from a lot of different investors. A lot of the people that I listened to on a lot of the podcasts, they talk a lot about, you know, eating their cooking. You know, that they have their money tied up in the same places that they recommend or have people pay them to invest for them. They do the same thing. I know Vitaly does. I know Toby does. I know Matt’s favor does; you know all those people. They all do. And that’s skin in the game for sure. Which is funny. It sounds like common sense and then you go out into the real world and you realize it’s not the case that you have to be careful, you know, whose advice you take.

Dave:                                    21:38                     Yeah, exactly. So the next point that he wanted to make along these same lines as he was talking about Warren buffet. So the world’s greatest investor, Warren Buffett, applied this when he formed his first investing partnership, buffered associates. The deal was that he would gain half the upside above a 4% gain, but pay a quarter of the downside to his partners, his skin in the game for the active investor. So he w his partnership, he had skin in the game because he’s stood to gain quite a bit if he did well and if he didn’t do well, then he, he suffered, suffered the price. So I thought that was interesting. All right. So I guess to wrap up some of my thoughts kind of, skin in the game is about asymmetry. A reaping the benefits of a positive outcome must be also be associated with paying the penalty to the negative ones.

Dave:                                    22:31                     Some less obvious consequences is skin in the game is that minorities can sometimes rule over majorities. You can make yourself smarter, and this can help you in many, many different situations. We tend to perceive quality in situations where there’s no skin in the game. The bottom line is investors can use the skin in the game. Sure advantage by ensuring the people that they entrust their money to are sitting in the same boat. And it’s always, you know, great to think about the people that you are, you know, take advice from whether it’s investing. It could be a worker weighted; it could be personal — any of those kinds of things. You have to think about what, what can you learn from these people and what do they have to gain from passing along their knowledge? Or how can they help you?

Dave:                                    23:19                     Is that helping them to help themselves or do they have skin in the game? Are they, you know, are they investing with their own money and buying the same companies that you are? Are they following the same advice that they give you at work? Any of those kinds of things. You know, there’s a lot to be gained from the skin in the game. And I, I think it, that gets the two big takeaways for me were one that, you know, thinking about how your actions have consequences and you know, if you have risk and you have passion and you go for things, you’re going to feel that much more rewarded when you achieve it. What it is you want because you’ve, you know, put your skin in the game so to speak. And I’ve also thought about how much it helps motivate me in particular to learn more about what it is that I’m passionate about.

Dave:                                    24:12                     I want to think about investing, and I think about helping all the people that we try to help through our podcast. It inspires me to continue to try to learn and grow and get smarter and better at what I’m doing so that I can help more people because I feel like that’s something that I want to pass along to other people and help as much as I can because that’s why we’re all here in the world. And when I read this book that kind of struck me as I was reading the book, it was, you know, he, he refers to all these different stories and him, he comes back and back again to all these different points. And, you know, for somebody dense like me, it helps strike home what he was trying to say. And it took a lot away from the book.

Andrew:                              24:57                     Yeah, I like that. I think I think your passion shows, and it’s easy, like from my standpoint too, it’s a lot easier to get excited and, and be a nerd about learning and digging into stocks when we’re able to pass it along. And, and maybe that’s a hidden lesson in of itself too. When you get to a point where you feel you’re, you’re comfortable, you know what you’re doing and it’s working for you, and then if you pass it along to somebody else as well, that can give you an extra skin in the game and help you hone your abilities. I know it’s certainly helped me. So from uneven, Unintentionally passing the knowledge along in the sense of like not understanding that that that can be a huge asset for you too because that added skin in the game helps you get focused and figure out what you’re doing and, and I think that can lead to better results over the longterm.

Dave:                                    26:02                     All right folks, we’ll that is going to wrap up our discussion of Skin in the Game today. I hope you enjoyed our conversation and my thoughts on the book review. I highly recommend all of his books. I haven’t read all of them yet, but from everything that I’ve read about them, they are fantastic reads and you can learn a lot from him. Very, very smart guy. You can find all of his books on audible as well as at Amazon. So without any further ado, I’ll go ahead and sign us out. You guys go out there and have a great week. Invest with a margin of safety and we’ll talk to you all next week.

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