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Taleb's Black Swan

In 2007, economist Nassim Nicholas Taleb authored the now-famous book on randomness and empiricism: The Black Swan. Taleb's Black Swan quickly became a term for events which are extremely rare,¬†unforeseen, and have a disproportionate impact. In the context of economics, black swans are particularly important because the types of analyses and predictions which economists and finance workers perform are inherently vulnerable to black swan events. If the manager of your hedge fund isn't well educated about risk and black swans, you could be setting yourself up to lose a lot of money very suddenly-- or potentially, to become rich overnight unintentionally, though it's less likely. \ \   \ \ A recent example of a black swan is the financial meltdown of 2008. Many people lost their homes, pensions, and savings in one massive collapse; this wasn't really preventable, but it was possible to profit from the financial meltdown if you played your cards right. How did anyone possibly profit from the financial meltdown? It's Taleb's personal strategy: bet on black swans. \ \   \ \ By betting small amounts of money on highly unlikely events, Taleb constantly loses small amounts of money, because highly unlikely events rarely happen, by definition. When they do happen, however, Taleb get a disproportionate payoff which massively dwarfs the size of his losses. Thus, the strategy of constantly losing money ultimately pays off big, assuming you can afford to do it. To know probabilities of events is the job of an actuary, but it's possible to do non-rigorous informal assessments on your own. \ \ Not all of us can afford to profit off of black swans, though. The rest of us must learn to live with the possibility of black swan events, and try to protect ourselves as best we can, so that we may survive when the unthinkable happens. The thought to keep at the front of your mind is, "what would happen if an investment that I take for granted as relatively safe is suddenly made worthless? How much will I lose?" By introducing the concept of doubt into "safe" investments, you are already starting to defend yourself against black swans. \ \ Understanding that even safe investments may fall through isn't enough to protect yourself from black swans, though. You must actively protect yourself by having an empirical understanding of the chances of safe investments falling through, and also by diversifying your safe investments, such that if a black swan event causes one to collapse, you have backup plans which are more robust. Picking a black swan resistant portfolio is a tough task, but professional actuaries and finance managers worth their salt have heeded Taleb's warnings about black swans, and can now frequently assist consumers with making prudent portfolio choices. Some skepticism is in line for all portfolio choices made for you, though. All finance professionals who you hire to assist you have an agenda which likely supports their institution, and their portfolio choices will reflect this. Saying that an investment is safe does not make it so, even if many people invest and believe it to be safe. The forces of the market are subject to nearly unpredictable events such as black swans, and simple adherence to the conventional wisdom is not enough to keep you safe.