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The Black Swan theory

I came across a really thoughtful theory this morning – The Black Swan Theory.

This theory talks about taking into consideration high-impact, tough-to-predict, rare events beyond the realms of human imagination. We humans are hopelessly poor in predicting the future. We underestimate the extremes in our range of outcomes. We jump to conclusions using every piece of information that confirms out outlook and conveniently ignore the ones that make us rethink.

So what happens if these extremes occur? These unexpected events have a far more significant impact on us compared to those mundane, predictable events taking place daily. For instance, take 9/11 or the invention of the Internet or the dot com crash or the great depression or the personal computer, world war one or even the ongoing sub prime crisis – all these events have had an epochal impact on us.

Now think monetarily. Few who predicted such events were in far better shape than most. For some, their losses were minimal. For some more, they even made some money. And for many others, lots of money!

The black swan theory could be a smart tool for investment. Lets say, you invest 85-90% on regular, predictable, safe bets. Now, how about finding those ‘black swans’ for the remaining 10%? Think of some radical ideals to bet on as black swans. What could be the next big thing that could happen in a year or two? Technology breakthroughs, global recession, war, revolution, peace, hyper inflation etc. Sure, you may not have a well-defined ROI or, for that matter, not even know where to bet or if it is even practically possible but just think about it. It is a start. Consider the what-if scenarios! The idea is not to invest in these as a fall back option (for a rainy day) but use these to spread your portfolio. To make some money. Don’t expect to win many of them. But the ones that you win, will be nothing less than a jackpot.

And how about using this theory not just for investments but also in our personal lives? Is it possible?


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