Expect Black Swans
A Black Swan is an unpredictable event that dramatically changes the future. The term was coined by Nassim Taleb and made well known through his book, The Black Swan: The Impact of the Highly Improbable. The term makes reference to the old belief that there were only white swans, and seeing a "black swan" was akin to seeing "pigs fly". A few examples of Black Swans are electricity, World War I, computers, September 11th, the Boxing Day Tsunami, Hurricane Katrina, and the recession of 2008. Although Black Swans represent a very small fraction of events, they are the key drivers of history and have far more impact than the majority of more predictable commonplace events.
Understanding Black Swans leads us to the conclusion that the future is unpredictable. While few educated people believe in fortune tellers, many do believe in the ability of market forecasters, even though data shows them to be equally dubious. If the future is unpredictable, market forecasting is unreliable at best both due to every day volatility and Black Swan (or even their counterpart, positive "White Swan") events. These events can occur at every level of depth, from an individual or company to an industry, even to the entire planet.
You should expect Black Swans to occur and plan accordingly. But how can you plan for an event if you don't know when it will occur or what it will be? The answer lies in redundancies and insurance. While it's impossible to predict the timing and nature of the next Black Swan, you can put yourself in a better position to survive and even prosper during such an event through diversity or robust redundancy.
To make yourself less vulnerable to the negative affects of a Black Swan you should have:
- No debt
- Multiple sources of income
- Diversified savings
Debt will magnify both the risk of being affected by a Black Swan and the severity of the affect. By carrying debt your predictions for the future must be more accurate in order to maintain or increase your position, as incorrect predictions will put you under faster. In addition, if complete financial disaster strikes you'll have more obligations than had you no debt.
Insurance can cover you against Black Swans that cause high health care expenses, property loss, and law suits. These three expenses are the cause of many bankruptcies, and can be especially stressful when combined with a catastrophic Black Swan event. Insurance will serve as a financial buffer and limit your losses.
Having multiple sources of income will dramatically increase your chances of prosperity should one source collapse. If you're retired and relying on your investments to produce income, you should be investing in various and unrelated assets. If you're working a single job and unable to create a second income source, it would be wise to have a plan to create another source in case of emergency.
Savings are both a source of money and a form of insurance or protection in case you need it. Remember that savings are different from investments. The point of investments is to generate income, while savings should be secure but inflation resistant. Many people neglect to diversify savings and put their savings only in single currency cash assets such as CDs, bonds, or treasuries. In Black Swan events currencies can be dramatically devalued. It's highly likely that this will happen at some point in the future to many currencies. By diversifying your "cash" savings into multiple currencies and commodities you can avoid the affect that a Black Swan may have on your single currency savings. To be better protected, consider having a higher percentage of your assets in diversified savings than investments that are more vulnerable to Black Swans.
Flexibility is perhaps the best quality to have to survive a Black Swan. Of course having zero debt, insurance, multiple sources of income, and diversified savings gives you flexibility. But mental flexibility and a willingness to adapt will go a long way. When a Black Swan is coming crashing toward you, the flexibility to move out of the way and change paths is invaluable. To be more flexible you may consider renting vs. owning (allowing you to get up and go with no strings attached at any time), investing in your own knowledge (giving you more options to create income and opportunities for yourself), and being open to making lifestyle changes.
Planning for what you don't know may be more important than planning for what you do know. In addition, expecting and preparing for Black Swans will give you peace of mind, as you'll be less concerned about market fluctuations and either man made or natural disasters.