What is a Black Swan Event?
In the 19th century, John Stuart Mill described seemingly impossible events that may one day be proven true as Black Swans. In the Western world, all swans were thought to be white until, in 1697, a dutch explorer spotted black swans on the shore of the Swan River in Australia. This story shines a light on how little we can truly say is true.
A consequential black swan event, the 2008 financial crisis, was said to be impossible. Nevertheless, a confluence of factors led to the financial crisis, most notably an opaque financial system. Millions of people were unprepared. Some had mortgages they couldn’t afford and, as a result, lost their homes. There are two primary lessons we should take away from a black swan event like the financial crisis:
- Humans are bad at predicting the likelihood of black swan events due to the complexity of our global financial system.
- We need to prepare for the possibility of these events, no matter how unlikely they may seem.
Black Swan Events are not limited to finance, of course. The 9/11 terrorist attack was a Black Swan Event we were very unprepared for. Catastrophic hurricanes, or “perfect storms,” are also Black Swan Events. I explain how to prepare for non-financial catastrophic events in previous posts. In this post, we’ll focus solely on financial Black Swan Events. We can be proactive in protecting ourselves against financial hardship in the event of a crisis. Let’s discuss how.
How to Prepare for Black Swan Events
The financial crisis was so problematic due to irresponsible assumptions of debt and predatory bank practices. I won’t go into detail about adjustable rate mortgages, mortgage backed securities, or some of the other financial products that ultimately led to the recession. Instead, I will share some tips on how we can protect ourselves going forward.
Perform Due Diligence Before Signing a Contract
Many home buyers were taken advantage of before the financial crisis. Buyers purchased homes they couldn’t afford because real estate agents and mortgage lenders told them their dreams were within reach. We need to determine what is actually affordable. Exercise caution when working with people who have financial incentives to sell us costly goods. If my real estate agent gets a larger payday if I buy a larger home, then I should do my own research throughout the entirety of the buying process.
Contribute to a “Rainy Day Fund”
Savings are critical to your financial security. During the recession, many people were laid off from their jobs. As a result, mortgage payments were missed and homes were lost. It is therefore so important that you create a rainy day fund to protect yourself. Have enough money to pay your financial obligations for a short period of time if you lose your main source of income. You may need to make some sacrifices in order to do so, but those sacrifices will pay off if another crisis emerges. If no crisis emerges, then you’ll simply enjoy a more comfortable retirement.
Develop Additional Streams of Income
If you have a single stream of income, then you are incredibly vulnerable to market disruptions or the shifting needs of your employer. If you have an alternative income stream, then you can stay afloat if your main source of income disappears. Yes, this is easier said than done. We’re preppers, though. We can go the extra lengths to do what needs to be done to prepare for the worst case scenario. We can leverage our skills to develop side businesses, or sell items we no longer need. By investing your time in developing an additional income stream, you are flexing your entrepreneurial muscles. You can supplement your current stream of income and contribute more to your rainy day fund. In doing this, you are making yourself less vulnerable.
Shielded from the Next Financial Crisis
We can prepare for Black Swan Events through research, sacrifice, and ingenuity. Let’s be sceptical of those who are compensated more when we spend more. Join me in building savings early. Carve out opportunities to supplement the income you make from your day job. The next financial crisis does not need to be a personal crisis. We can make ourselves immune to the next one.
Have any other tips on preparing for Black Swan Events? Leave a comment, or contact me directly.