Black Swan Events: Understanding the Unpredictable and How to Prepare

Risk is what we don't see. It is what is left after we think we have accounted for everything.

When it comes to investing, a big obstacle many people face is the fear of catastrophe. If you invest in a stock, there’s always the possibility that the value may drop to zero. In fact, at Sterling Edge Financial, we used to have a wall in the office lunchroom that was covered with stock certificates from liquidated companies. Most of those businesses likely had good ideas and solid plans. After all, they had reached a level of success that allowed them to go public. And yet, eventually, each stock certificate was worth only the paper it was printed on.

This fear of the unknown often leads to discussions about black swan events. Popularized by Nassim Nicholas Taleb in his 2007 book, The Black Swan: The Impact of the Highly Improbable, the term refers to unforeseen, rare events that have massive impacts on markets, economies, or even history itself. These events are nearly impossible to predict, and when they happen, they change the game entirely.

Examples of Black Swan Events

Let’s look at some historical black swan events that had seismic effects:

1. The Financial Crisis of 2007-2008: Triggered by the collapse of the housing market and risky mortgage-backed securities, this event led to a global economic meltdown. Major financial institutions failed, unemployment surged, and trillions of dollars in market value vanished. It remains one of the most impactful financial crises of modern times.

2. The Collapse of Long-Term Capital Management (1998): Long-Term Capital Management (LTCM), a hedge fund run by financial experts and Nobel laureates, collapsed after highly leveraged bets went wrong during the Russian financial crisis. The event shocked markets and required a bailout to prevent a broader financial collapse.

3. The COVID-19 Pandemic (2020): The global economy ground to a halt as the coronavirus pandemic spread. Markets plunged in March 2020, and entire industries faced unprecedented disruptions. However, governments and central banks stepped in with fiscal and monetary support, and markets eventually recovered.

4. Brexit (2016): The unexpected vote by the United Kingdom to leave the European Union sent shockwaves through financial markets. Global stocks dropped sharply as uncertainty about trade, economic stability, and geopolitical relationships loomed.

5. The Collapse of Government in Syria (December 2024): The sudden breakdown of the Syrian government created turmoil in the region, leading to political instability, a refugee crisis, and economic uncertainty that rippled through global markets. This event underscores how geopolitical factors can unexpectedly impact investments.

Black Swans and Perspective

At Sterling Edge Financial, we take a slightly different perspective on black swan events. Drawing from decades of experience and optimism about public markets, we believe that while markets can experience significant downturns, they have a powerful history of recovery. For example, during the early 1970s, markets dropped more than 40%, yet they rebounded over time. Even the 2008 crisis, which many believed to be catastrophic, was followed by one of the longest bull markets in history.

Managing Risk: The Power of Diversification

For many investors, a 20% market decline can feel catastrophic, particularly for those nearing retirement. That’s why controlling risk is critical to a long-term financial plan. By holding a well-diversified portfolio—a mix of stocks and bonds tailored to your needs—you can minimize the impact of a market downturn. For example:

• If half of your portfolio is in stocks and half is in bonds, a 20% drop in stocks reduces the overall portfolio value by only 10%.

• Diversifying further, such as investing in a global portfolio or market-wide index funds, spreads your risk across thousands of companies worldwide.

This approach works because winners can gain far more than losers can lose. While a stock can fall to zero, the growth of successful companies is uncapped. Take companies like Nvidia, whose stock price has multiplied many times over in recent years. This asymmetry is one reason we remain optimistic about public markets over time.

What You Can Control

While black swan events are unpredictable, your response doesn’t have to be. Here are a few key takeaways:

1. Diversification Is Protection: Think of a diversified portfolio like owning a small part of thousands of companies, much like spreading the risk of buying one house across thousands of homes worldwide.

2. Understand Your Plan: Having a clear, trusted process allows you to stay disciplined when the market tests your patience.

3. Focus on Long-Term Goals: The market’s average annual return of about 10% over the last century1 highlights the importance of staying invested and avoiding emotional decisions.

At Sterling Edge Financial, we believe that with the right strategy and mindset, you can navigate uncertainty—even black swan events—while continuing to pursue your financial goals. By focusing on what you can control and trusting a process that has stood the test of time, you are better positioned to win in investing and in life.

Footnote:

1. In US dollars. Based on S&P 500 Index annual returns, 1926–2023. S&P data © 2024 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.

For more guidance on navigating financial uncertainty and black swan events, contact Sterling Edge Financial. Together, we can build a plan that helps you stay prepared, protected, and confident for the future.