Black Swans

Events That Are Impossible To Predict, Rare and With Devastating Consequences


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Black Swans - Overview

Black Swans are events that are difficult to predict, occur very occasionally and have potentially severe consequences.

Nassim Nicholas Taleb the mathematical statistician, former option trader, risk analyst, and writer brought the concept to popular attention in his book, "The Black Swan: The Impact Of The Highly Improbable"

Taleb describes black swans as an event that:

  1. Is so rare that it is not on the radar to extent that even the possibility that it might occur is not known.
  2. Has a devastating and catastrophic impact when it does happen.
  3. After the event is rationalised as though [with the benefit of hindsight] it was actually predictable.

It is not possible to use statistical data from past events to predict future black swans and Taleb argues that the standard tools of probability and prediction do not apply since they require massive population and past sample sizes that are just not available for these rare events.



    It is extremely foolish to just ignore the potential for black swans to occur.

    To take the view that because we cannot predict them we will pretend they don't occur is setting yourself up for trouble  - which of course is exactly how most individuals, companies and governments operate.


We will be considering below, in some detail, strategies and steps that you can utilise to be better prepared for black swans when they do occur. But first, here are a few examples of relatively recent black swan events.






Examples Of Black Swans

Classic black swans include the rise of the internet and personal computer, the September 11 attacks, and World War I.

Here, courtesy of Investopedia are futher examples:

"The crash of the U.S. housing market during the 2008 financial crisis is one of the most recent and well-known black swan events. The effect of the crash was catastrophic and global, and only a few outliers were able to predict it happening.

Also in 2008, Zimbabwe had the worst case of hyperinflation in the 21st century with a peak inflation rate of more than 79.6 billion percent. An inflation level of that amount is nearly impossible to predict and can easily ruin a country financially.

The dotcom bubble of 2001 is another black swan event that has similarities to the 2008 financial crisis. America was enjoying rapid economic growth and increases in private wealth before the economy catastrophically collapsed. Since the Internet was at its infancy in terms of commercial use, various investment funds were investing in technology companies with inflated valuations and no market traction. When these companies folded, the funds were hit hard, and the downside risk was passed on to the investors. The digital frontier was new so it was nearly impossible to predict the collapse.

As another example, the previously successful hedge fund Long-Term Capital Management (LTCM), was driven into the ground in 1998 as a result of the ripple effect caused by the Russian government's debt default, something the company's computer models could not have predicted."












Preparing Yourself For Black Swans

Adopt The Boy Scout Mentality - "Be Prepared"

Antifragile is a term coined by Nassim Taleb to represent things that benefit from disorder.

In his book Antifragile: Things That Gain from Disorder he says:

"Some things benefit from shocks; they thrive and grow when exposed to volatility, randomness, disorder, and stressors and love adventure , risk, and uncertainty.

Yet, in spite of the ubiquity of the phenomenon, there is no word for the exact opposite of fragile. Let us call it antifragile. Antifragility is beyond resilience or robustness.

The resilient resists shocks and stays the same; the antifragile gets better"



    The best way to be prepared for Black Swans is to understand and develop the qualities of antifragility.

    Antifragility is the quality of something that gets better, or thrives, in the presence of disorder.








So what makes something antifragile? Below are a few of this quality’s key characteristics:


# LESS IS MORE

Less is usually more with antifragility. According to Taleb: “the first step towards antifragility consists in first decreasing downside.”

To become antifragile, it pays to be small. With smallness comes increased agility and flexibility during volatile and chaotic times."

Let your motto be "Less Is More" always look for Subtractive Solutions

Knowledge grows by subtraction much more than by addition – given that what we know today might turn out to be wrong, but what we know to be wrong cannot turn out to be right, at least not easily.”


# STACK UP YOUR BACK UPS

Antifragile things have built-in back ups.

Unlike fragile systems/organizations/people, antifragile things don’t make efficiency the primary goal.

For the antifragile, thriving in randomness is the goal, which often requires being “inefficient” through stacking up your back ups

Add backups in your life.

Start that emergency fund; add buffers to your schedule to take into account the inevitable volatility that comes each day.

The gains from having back ups increase as volatility increases.


# STRETCH STRESSING

Intentionally inject stress in your life. While long-term stress can have negative effects on your mind and body, short bouts of it can make you stronger and better.

Your body and mind have antifragility built into them, but require stress for that antifragility to activate. A few suggested ways to inject positive stress into your life: fast, take cold showers, do a challenging obstacle race, lift heavy weights, run instead of bike.


# TWO PRONGED STRATEGY

Employ the “barbell strategy.” Taleb describes the “barbell strategy” as “a dual attitude of playing it safe in some areas and taking a lot of small risks in others, hence achieving antifragility.”

Playing it safe reduces the potential downside of volatility and taking small risks exposes you to the potentially massive gains from the same chaos.

For the "Average Joe" it could mean keeping your boring day job (the safe end of the barbell), while working on your side hustle at night (the risky end of the barbell). 

If the side hustle doesn’t work out, you still have your boring job, but if it does work out, you could live the dream of working for yourself and becoming wealthy.


# NO SKIN NO LISTEN

Never take advice from someone who doesn’t have “skin in the game.”

We live in a world in which people’s actions, opinions, and advice are divorced from consequences.

Financial advisors on TV can give terrible advice and pundits can spout off wrong opinions but suffer no consequence for their erroneous predictions, even if those predictions harm others.

When determining whether or not to take advice from someone, look to see if they have skin in the game. If the person dispensing the advice or making the prediction has nothing to lose from being wrong, don’t listen to them.

Pay more attention to people who have accepted risk and responsibility for their words.


# HAVE OPTIONS

Keep your options open. When volatility and chaos increase, it’s the man with the most options who is the most antifragile.

How do you increase your options? Having money in the bank certainly increases your options; it gives you breathing room during economic downturns, but also provides flexibility to take advantage of positive unforeseen opportunities or to pursue goals.

Increasing your skills gives you options as well. If one career goes bust, you have the skills to jump-start a new one.


# THE RULE OF 2

This is a rule I first developed as a young salesman when I was required to produce weekly and monthly sales forecasts.

Here is how the rule of 2 works.

When you have made your forecast for upcoming sales revenue [or profit] half it.

When estimating when the deals will close, double the lead time.

I eventually extended the rule of 2 to other areas of life, for example when estimating the cost of refurbishment project on an old property I would work out the budgeted costs - and then double that figure and assume the costs would accrue in 50% of the time my cash flow forecast indicated.

In summary, double all costs, half all revenues, and assume cash flow on costs occurred in 50% of the time fore-casted [i..e they had to pay paid in month two rather than month four as per forecast], and assume all revenues and incomes took twice as long as expected to come in [i.e. revenues projected to come in during month to are revised to accrue in month 4.

This may sound extreme, but this approach served me well. Although at the time I had never hear of the word - this is an antifragile approach to managing finances.








"Two Is One and One Is None"


Members of the US military have a maxim that neatly sums up Taleb’s philosophy: Two is one and one is none.

If you bring one piece of gear on a mission, it’s bound to break, and when it does, you’ll find yourself in a real pinch.

Far better to have not only a Plan A and a Plan B, but a Plan A, B, and C. Former Navy SEAL Richard J. Machowicz calls the intentional creation of strategic back ups “advantage stacking”:

“...you want to stack so many of the advantages in your favor that, when the order comes, when the opportunity presents itself, you can’t help but win.”

Two is one and one is none” may sound fatalistic, but it’s also realistic; Murphy’s Law is far too often in effect.

Or as Taleb puts it: “Redundancy is ambiguous because it seems like a waste if nothing unusual happens. Except that something unusual happens—usually.”


Tactical Back Ups 

Courtesy of "The Art Of Manliness" here are just a few examples of how back ups can help you thrive when your best-laid plans go awry:

72-hour survival kit.

"If a natural or man-made disaster cut off your water and electricity, would you be prepared to weather the storm? While survival experts recommend having several months to a year of emergency food, water, and supplies on hand, a simple 72-hour kit is easy to assemble and store, and will see you through most emergencies."

Extra pen/pencil during important meetings and exams.

"You’re at an important meeting with a client, pull out a notepad, and are about to get things underway when you realize your pen is out of ink. Asking the client if you can borrow one makes you look unprepared, and you haven’t even gotten going yet!"

Alternative form of transportation.

"My wife and I share a car. The other day she had it, and I needed to get to the store right before it closed. I could have made it on bike had I owned one, and I cursed not having a 2-wheeled conveyance. A bicycle or motorcycle (or even a horse, a la Rick in The Walking Dead) would come in handy during the apocalypse too; when car loads of people trying to get the hell out of dodge clog the streets, you can slip through the deadlock."

Side hustle/valuable hobby.

"Very few jobs offer much security these days. You could be given the boot without warning, and then what? If you’ve been cultivating a side hustle all along, you’ll already have a back-up income source in place, and you can either live on that until you find another full-time job, or try to expand it into a full-fledged business. If you don’t have a side biz outside your 9-5, consider developing a potentially valuable hobby. Maybe you do woodworking as a pastime right now – if your corporate gig falls through, you might be able to pivot into making furniture full-time."

A library of physical books.

"There has never been so much information at our fingertips…and it has never been so fragile!  If your whole library is stored on various devices, and that technology fails, or even simply changes, you won’t be able to access it. That’s part of the reason I buy a physical copy of all my favorite books. I’ll never curse the fact that I need some unavailable widget to start reading them – I can simply open the cover and dive in."

Memorized knowledge and skills.

"If physical books are a back-up to digital copies, memorized knowledge is a back-up to your books. Having something like a survival Kindle to fill in the gaps is a great idea, but strive to memorize as much practical and life-saving information as you can."

Written notes.

"It’s great to memorize the ideas of others, but what should we do when we come up with one of our own? We often think of to-dos and great ideas, and then rely on our memory to capture and preserve them. Later we bemoan our inability to retrieve the thought we were sure we wouldn’t forget. Buttress the fragility of your ideas by writing them down in a pocket notebook."

Emergency fund

"Kids end up in the emergency room; your car goes kaput in the middle of New Mexico; you unexpectedly get laid off from your job. We’ve all experienced these setbacks and their accompanying bills. Many people don’t plan for emergencies in their monthly budget, so when the poop hits the fan, they’re forced to take on expensive credit card debt. An emergency fund is insurance for you and your family – an antifragility must for every man."

Alternative form of currency.

"If the poop really did hit the fan, our regular currency would become worthless. That’s why it can be a good idea to have an alternative form on hand — some gold perhaps, or that universal medium of exchange, cartons of cigarettes."

Earning a double major in college.

"It often doesn’t take a tremendous amount of extra effort and time to earn two majors in college instead of one. Not only does it allow you to pursue two different interests, but, if you can’t find a job related to the first major after you graduate, you have the option to pivot towards something related to the second."

Analog watch.

"Many men have given up on wearing watches, as they use their smartphone to check the time. But a phone battery can die, torpedoing your punctuality. Plus, an analog watch can double as a compass, should you become lost in the woods."

Back-up to your hard-drive.

"No one knows when their computer will go completely kaput – or be stolen. When it does, sometimes your files cannot be recovered. You can lose your life’s work, not to mention all your photos and music. Everyone should use a device that backs up their computer’s hard drive without their even having to think about it."

A large network of acquaintances and core group of good friends.

"Having a solid network of relationships can help us thrive professionally, especially during rocky times when our business craters or we find ourselves out of work. And when it comes to your personal friendships, you can never have too many “back ups.” It’s great to have one best friend you’re incredibly close to, but what will you do if/when he moves away? Some men don’t even have that – they try to go through life entirely on their own. When hard times come, these isolated loners crumple without needed support."






Further Reading:

Antifragile

Nassim Taleb


Return from "Black Swans" to: Mental Models





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