Black Swan Events

As we have come to find, significant events (both globally and domestically) can have considerable impacts on the financial markets. Further, such events can come in many forms and, in some cases, are extremely unpredictable. Interestingly, there is a term for such events, “black swan events”, as coined by Nassim Nicholas Taleb via his “Black Swan Theory.”

The concept of a black swan event was originally developed by Taleb following the financial crisis of 2008. Basically, his argument was that there were certain events that could/would have disastrous consequences but were not possible to stop without hindsight. As result, individuals should assume that black swan events are possible at any point in time and prepare accordingly. This means taking precautionary financial measures. Surprisingly, there can be a silver lining associated with black swan events. Continuing to use the 2008 financial crisis as an example, the event highlighted how a broken system (that was allowed to fail) presents the opportunity for advancement in order to avoid future similar black swan events. In the short-term, the negatives might seem to outweigh the positives here, however, in the long-term the push towards a more perfect system could prove to be of greater importance. With regard to your own portfolio, they could even lead to new investment opportunities.

To better understand the economic implications linked to these events, it is key to know how they can be identified. According to Taleb, there are three common traits. First, the event must be a surprise — from the perspective of the observer or observers. Second, the event must have some sort of major effect. Finally, using hindsight, the event must be able to be rationalized as if it could have been expected. In other words, there must have been some sort of relevant data that could have been accounted for in risk mitigation but was not. To provide more context, according to Business Insider, there have been “9 black swan events that changed finance forever.” These events include: The Asian Financial Crisis, The Dot Com crash, 9/11/2001, The Global Financial Crisis, The European Sovereign Debt Crisis, The Fukushima Nuclear Disaster, the 2014 Oil Crisis, The 2015 Black Monday, and Brexit. If you want a deeper dive into these specific black swan events it might be a good idea to do some independent research on the one you find most interesting!

Ultimately, by its definition, you cannot anticipate a specific black swan event. That said, there are steps you can take in an attempt to protect your portfolio from a black swan event in general. For instance, a diversified portfolio exposes you to less risk as it is extremely unlikely for the value of all types of assets to crash simultaneously. Right now, investing in stocks, mutual funds, and exchange-traded funds are popular options, however, there are many additional options such as bonds, real estate, and precious metals — to name a few. Similarly, paying off debts is another step that be taken to help protect your portfolio from a black swan event. This is particularly true if you have significant high-interest debt such as from credit cards. By liquidating some holdings to pay off debt, you might at least be able to achieve a relatively stable balance sheet despite market conditions. In the end, black swan events are hard to avoid by definition, but you are not completely without options. Just like with any market change, it helps to know your options before making your next move!