When we say black swan, we don’t mean a large, rare waterbird with a long neck or the movie starring Natalie Portman. Nope, we’re talking about an unpredictable, unique event that significantly shapes the world. Black swan events are unexpected moments in history and are considered anomalies, meaning that they deviate from the norm. They affect the financial markets, the global economy, and can significantly impact investors. It is essential to understand what a black swan event is and how it can affect your portfolio to protect yourself as an investor.
First, a little background: Where did the name originate? For years, no one thought that black swans (the bird, not the event) existed because no one ever saw one. To everyone’s surprise, a black swan was finally spotted, and social scientists began to use the rare bird as an analogy for a unique occurrence.
One book stands alone as the authority on black swan events and how they affect financial markets and the world at large. The Black Swan: The Impact of the Highly Improbable by Nassim Nicholas Taleb was published in 2007 shortly before the 2008 Financial Crisis. In it, Taleb argues that chance and unpredictability are much more common than people realize. He says the presence of a black swan relies on three things: “rarity, extreme impact, and retrospective predictability.”
How Does A Black Swan Affect Investing?
Understanding what a black swan event is and how it can impact risk is key to becoming an informed and educated investor. It’s something that you never saw coming and can affect the world at large. That is why top financial managers do their best to hedge against black swans by spreading their risk across multiple investments.
For example, if a massive earthquake hits the San Francisco Bay Area, Silicon Valley would be affected, and this could be considered a black swan. If that happened, many technology stocks could decrease in value. If you invest in only technology stocks, you could potentially lose the benefit of those stocks. But if you diversify and spread your risk by investing in a variety of different sectors, you would have more of a chance to hedge against the risk of a black swan.
Examples of Black Swans
There have been a few events over the past 100 years that can be considered black swans.
The great Wall Street crash of 1929, also known as Black Tuesday, is one of the most devastating examples. This stock market crash threw our country into the Great Depression, and the repercussions were felt worldwide.
The terrorist attack on September 11, 2001, is also considered a black swan since it stands apart in scale, scope, and magnitude in comparison to preceding terrorist attacks.
The Financial Crisis of 2008 was the most recent black swan event. While movies like The Big Short and Inside Job sensationalize and amplify the personalities of the select few people who predicted the crisis, it was an incredibly improbable event. The fact that very few were able to identify the housing collapse beforehand and the repercussions of this mistake made it one of the most significant events of the 21st century. The 2008 Financial Crisis has changed the way Wall Street is run, the way risk is balanced, the granting of credit and loans to Americans, and the way new investors view the stock market.