Within the same book above, the ‘black swan’ theory is expanded by American trader–Nassim Nicholas Taleb. A widely used term in the finance realm, it describes unexpected economic, political, and social events that are certain to occur but cannot be foreseen.
The concept of a black swan event has its roots in history. Back in the day, people believed only white swans existed. However, everything shifted in 1697 when a Dutch explorer stumbled upon black swans in Australia, turning the assumption on its head. This unexpected discovery not only reshaped perceptions but also had a profound impact on zoological theories.
With the introduction of the term “black swan event,” Taleb aimed to paint a clearer picture for people worldwide, illustrating the possibility of unpredictable events taking centre stage at any juncture which can affect all areas of life.
As per the author’s insights, a black swan event exhibits the following three distinct criteria. The first is that it should be unexpected—an outlier in its own right. These events defy the norms and preconceived notions, standing out as exceptions where nothing in the past can credibly suggest their occurrence.
Secondly, a black swan event wields a meaningful influence on society or the world—an impact that resonates deeply and leaves a lasting mark.
The third criterion involves a Black Swan event becoming discernible only in the aftermath. Even though it’s not foreseen beforehand, it becomes clear in hindsight, leading people to question why they weren’t ready for it.
Between 1995 and 2001, the “Dotcom bubble” unfolded—a fervent chapter in financial history. Back in those days, the Internet was a beacon of potential, and American tech firms were at the forefront. Investors, fueled by boundless dreams, sent stock prices soaring, while innovative startups promised a digital utopia. Amidst grand visions, many companies stumbled under unfeasible expectations, triggering a wave of bankruptcies. The late ’90s euphoria transformed into the sobering reality of the early 2000s as the bubble burst, leaving investors with massive losses totalling about $5 trillion.
Another example of a black swan event is the 2008 financial crisis, which happened just a year after Taleb’s book was published. In the tumultuous year of 2008, Wall Street was shaken by a series of shocks caused by the collapse of subprime lending practices. The once-sturdy stock prices nosedived, corporations laid off employees by the masses, and banks claimed ownership of countless homes through foreclosure. The financial landscape was akin to a house of cards teetering on the edge. Only with massive government funds and central bank help was the global financial system’s catastrophic collapse averted.
In the face of unpredictability, there’s only so much one can do to prepare for them. Nevertheless, one primary strategy that Taleb presents in his book touches upon the importance of risk management. Known as the barbell strategy, it involves allocating the bulk of an investor’s funds to ultra-safe assets whereas a small fraction is assigned to speculative ventures. The risky segment of the portfolio is capped at 10% of the total. The rationale lies in shielding the majority of the capital during market turmoil while giving high-risk endeavours a chance to surge.
To tackle the impact of a black swan event, investors can embrace diversification. Traditionally, when one market segment thrives, others tend to lag. By cultivating a diversified portfolio, investors can tap into growth across various market scenarios, ensuring they’re not putting all their eggs in one basket and increasing their resilience to unexpected twists.
In the realm of the unknown, black swan events serve as significant reminders that life is brimming with surprises. Through comprehending, preparing for, and adapting to these infrequent yet impactful incidents, we have the potential to enhance our resilience and refine our strategies. The teachings of the black swan instil in us the value of embracing a dynamic mindset, exercising caution in risk management, and keeping an open mind for the unfamiliar challenges that lie ahead. In simpler terms, it’s about preparing for the worst while hoping for the best.