Ever heard of a Black Swan? In this instance, we’re not referring to the 2010 Darren Aronofsky thriller.

Here, we’re referring to events that are incredibly major, incredibly rare and incredibly consequential for the world at large.

And, they can have a huge impact on your investments.

What is a Black Swan event?

A Black Swan event – also known simply as a "Black Swan" – is a highly unlikely and unpredictable occurrence that has major repercussions the world over. Those repercussions are usually pretty dire ones.

Black Swan events are often discussed in the context of the financial world, but they’re not just monetary matters. They can be anything from natural disasters and health crises to wars, terrorist attacks, political uprisings and economic crashes.

Regardless of the type of Black Swan event, though, every one has three primary characteristics:

1. It’s of extreme rarity and entirely unpredictable
2. It has a massive impact, usually with catastrophic consequences
3. In hindsight, the factors leading up to the event were obvious

Where did the Black Swan theory originate?

The concept of a Black Swan event was devised by Nassim Nicholas Taleb, a mathematical statistician, risk analyst and former Wall Street trader. He popularised the idea in his 2007 book, The Black Swan: The Impact of the Highly Improbable

Taleb picked the term ‘black swan’ to describe his theory because it fit rather nicely with how real-life black swans were discovered.

T he widespread belief among Westerners used to be that all swans were white – because that’s all they’d ever known. In 1697, though, Dutch explorer Willem de Vlamingh stumbled upon black swans in Australia, a finding that changed everything people knew about the species.

If we look at this through the lens of a Black Swan event, we can see that the discovery was unpredictable and had huge implications. Plus, with the power of hindsight, it was pretty obvious. Numerous other animal species boast varying colours, so it made perfect sense that swans could, too.

What are some examples of Black Swan events?

A good example of a Black Swan event is one we’ve just lived through: the COVID-19 pandemic. True to the definition of a Black Swan event, the pandemic was unpredictable and had major, often severe consequences. After looking back, many experts could have predicted that the virus would spread across the globe.

Other notable Black Swans include World War I and World War II; the Great Depression; the Global Financial Crisis (GFC); and 9/11. Sure, there may have been red flags that indicated some of these would occur. Generally speaking, though, they were largely unpredictable.
You’d be forgiven for thinking Black Swan events are almost always bad news. But, not all of them are as ominous as the name suggests. Examples of Black Swans that have been more beneficial include the rapid growth of the internet and computers, the fall of the Berlin Wall, and fortuitous inventions like the microwave.

Each of these bears the hallmarks of a classic Black Swan event, yet the only difference is that their consequences aren’t necessarily bad.

Historically, how have Black Swan events impacted long-term investors?

Black Swan events have repercussions across every sector – including the financial markets. This means it’s nearly impossible to escape the impacts of one if you’re an investor.

Traditionally, Black Swan events are very unsettling to investors and typically bear negative ramifications: falling markets (usually rapidly), greater volatility in the market, and a lack of certainty among investors. As a result, there are often hasty exits by those who are too nervous to stick around and potentially watch their investments plummet.

However, even though the market tends to drop quite sharply as a result of Black Swan events, historically these declines have only lasted a few months at most. In most cases, markets have managed to recover fairly well – and fairly quickly.

That’s why many experts recommend that long-term investors stick with their investments throughout these periods of volatility because the markets will recuperate in time. Plus, with the right protection measures in place, long-term investors can shield their investments from the adverse ramifications of a Black Swan – more on these below.

How can investors protect themselves against Black Swan events?

While Black Swan events are practically impossible to predict, there are several things you can do to protect your investments against potentially severe consequences. Here are a few tips.

Expect the unexpected

While you can’t always be sure of the nature of a Black Swan event and how it’ll influence your investments, you should always assume that one is on the horizon. And, you should prepare your portfolio accordingly, ensuring it’s capable of surviving the unexpected.

Look at the investments in your portfolio and scrutinise how a Black Swan event could sway them. Ask yourself: are they within industries that are highly vulnerable to certain global events? Or, are they in more stable ones that could more or less maintain the status quo during a major catastrophe?

Diversify

Diversification is always a good idea, but especially in the face of an unpredictable and volatile event.

Don’t put all your eggs in one basket (or, all your money in one stock). Instead, your portfolio could contain a mix of asset classes, markets and industries, as not all will be affected by a Black Swan event in the same way.

Keep tabs on your investments

Consistently monitoring your investments, especially as a Black Swan event takes place, makes sure you’re on top of the event’s effects on your portfolio.

You could also opt to rebalance your portfolio in line with these effects, to ensure your investments are still helping you work towards your overall investment goals.

Maintain a rainy day fund

A separate pool of money outside your investments gives you liquidity in the face of massive uncertainty and volatility. This can reduce the risk of having to dip into your investments if you need to cover unexpected expenses.

Look for opportunities

Some investors see Black Swans as opportunities. This is because asset prices often drop and become undervalued as a result. These investors are good at identifying devalued shares and pouncing on them, then reaping the benefits when the price eventually corrects.

Think long-term

At the end of the day, don’t forget that long-term investing is all about sticking it out for, well, the long term.

As we know, markets tend to recover quite strongly following Black Swan events. Maintaining that perspective will help you stay resilient in the face of short-term volatility and possibly prevent any knee-jerk reactions to the market.

Are there any Black Swan event warning signs that investors should look out for?

One of the primary characteristics of Black Swan events is that they’re unforeseeable, or at least incredibly hard to predict. The factors that lead towards one taking place are complex and multifaceted, and often the outcome is complicated, too.

There may be red flags indicating the likelihood of a Black Swan, but it could be that only a few catch on to them. This was the case with the GFC, where a handful of financial experts saw it coming; and the COVID-19 pandemic, where some scientists warned about the likelihood of a global health catastrophe.

Many have tried to develop sophisticated models that can accurately predict a Black Swan event. But, many experts say that even these are unable to predict the contributing circumstances and aftermath of every single Black Swan to occur.

That being said, by adopting some of the tips above, you may be able to protect your portfolio from total disaster.