How Can We Prepare for Black Swan Events?
In this article, I write about some steps we can take to prepare for black swan events i.e. unpredictable, possibly catastrophic, events that disrupt our usual way of living. It is important to be aware of what we can do to prepare for them, even if we cannot see it happening.
Let’s introduce Cajun the Chicken. Cajun is a broiler chicken. He is fed on a steady diet every day. He doesn’t do much, except eat. Sometimes he plays with his friends. But his routine is mostly eating and sleeping. Nothing exciting happens. One day, he is led out of his home and goes into another room. This entirely unexpected event is incomprehensible to Cajun. Yet he is on his way to fulfilling his destiny as per his name. Nassim Taleb calls this event a “revision of belief”, in his book, The Black Swan.
The last day of the chicken’s life is a black swan event. It is entirely unpredictable; no similar previous event has happened, even though it might have seen others go through the process too. Is that not like our daily life? We are lulled into routines and while we might know that death is an inevitability, we often lock it up in the recesses of our memories. We prefer to stick to the same routines and believe that the next day might not be too different from the last.
Research shows that the brain tries to find ways to save effort. We want to reduce processing. As a result, we are lulled into a false sense of security, because of routines and we start missing out signs. We start thinking that tomorrow would be like today, which is true - until it isn’t.
Black Swan Events in Our World
Black swans are by definition unpredictable. The phrase, “past performance is not indicative of future performance” is the acknowledgment of black swans, albeit in a more palatable way. But aren’t there warning signs? Unfortunately, real world events are often quite unpredictable.
Take Covid. China was reporting it as early as Jan 2020, yet most of the world simply looked on with limited concern. Chinese New Year 2020 in Singapore was as lively as previous celebrations. We were even planning for holidays in June 2020.
However, life turned upside down in April 2020. Singapore entered circuit breaker mode. We closed borders, closed schools and closed offices. Construction sites became deserted. Nature was given free reign as maintenance work like grass cutting was halted, and the grass grew wild. Movements were heavily restricted; we couldn’t even visit family members. Masks were compulsory everywhere. We had our movements tracked. If I painted this picture for you in Jan 2020, would you have believed it?
Drawing back to the chicken, we were like Cajun on the farm, watching friends being led away to another room, and never coming back. We might wonder what happened to them, but for the most part, we kept our normal routine. Until we were forced to change them.
Such events will come and go. New viruses, new economic shocks, and new threats will arise. They will shock us. They will impact our lives, often for the worse. They are by definition unavoidable.
However, unlike Cajun, such events in the real world are not always ‘unsurvivable’. Humans are especially good at surviving because we are innovative. We often seek to solve problems and are often forward-looking enough to anticipate the problems beforehand. Although Covid-19 took the world by storm, vaccinations soon came into the picture at record speed. It is a perfect example that humanity will overcome such unpredictable trials. . In fact, sometimes, ‘black swan’ events often present us with an opportunity to thrive. We can grow stronger after surviving each crisis if we do not allow black swans to overwhelm us.
How to Survive Black Swan Events
So how do we avoid black swan events from overwhelming us?
1. Recognise that Black Swan Events will pass
The important thing to note is that events will come AND go. Black swans will come AND go, and we will overcome.
2. Focus on survival
To overcome black swan events, we need to first survive them. All successful people, companies, and countries have the same trait. They survive. This is a necessary condition of success. If you cannot survive, you have failed.
The interesting thing about humans is our desire to survive. Our will to live propels us to overcome difficulties.
It is like being thrown in water; the first step is to ensure you don’t drown. Once you know you can float, you can then find a destination to swim towards. In the same way, once we have our basic needs covered, we can strive to overcome them and thrive. Maslow’s hierarchy of needs identifies some basic needs such as food and shelter. If we can meet these basic needs, we have the capacity to rise above the storm and find a way to thrive.
What can we do now to ensure our basic needs are always covered?
To ensure we can meet these needs, two tools can be employed: (i)Emergency funds and (ii) insurance.
(i) Setting up your Emergency Fund
Emergency funds allow us to meet our basic needs of food and shelter to tide us over. These funds need to be accessible at all times as we cannot predict when black swan events will hit us. Therefore, these funds need to be
a. Safe (the value must not fluctuate that much on a day-to-day basis) and
b. Liquid (easily accessible).
In Singapore, some of the available tools to store these funds are fixed deposits, high-yield savings accounts, and Singapore Savings Bonds. Such instruments do not face volatility in their value and are liquid. As a result, their returns are not spectacular, but that’s not an issue. We give up returns for safety and liquidity. The returns become a secondary issue.
(ii) Getting the right insurance
On top of emergency funds, the impact of a black swan event can be mitigated through the judicious use of insurance. It is important to note that no single insurance can cover every possible risk; every insurance is engineered for a specific risk. To be holistically insured, a range of insurances is ideal to ensure that we can mitigate the maximum risk. Here, we consider the insurances one should get as a base, before building up their insurance shield. Of all the insurance offerings out there, the most important ones to get are:
1. Hospital insurance
Hospital insurance ensures that our medical costs are managed. These policies reimburse the hospital bills incurred and help limit out-of-pocket expenses when the black swan strikes and we end up in a hospital. It ensures that our savings will not get wiped out.
2. Disability insurance
Disability insurance helps to protect our income stream. This class of policies pays out in the event that we are completely unable to work and helps to ensure we receive some level of income. Our income stream is protected.
Put together, these two policies help to mitigate a black swan that leads to
a. higher costs and/or
b. reduction in income
What does this mean for you?
The best approach is to have a deep discussion with a financial planner. The discussion revolves around balancing between the risk of an unknowable black swan event and living a good life. A good planner helps to create a holistic and complete financial plan.
The key thing to take away is the black swans will occur throughout our life; to be able to overcome, the basic need is to be able to survive. Surviving is much easier once we have some basic financial tools: emergency funds and a holistic insurance portfolio.