Fundamentals of Investing - Part V

BEWARE OF THE BLACK SWANS!

The ideas in this post are based mainly on the book entitled "The Black Swan" by Nassim Nicholas Taleb, so feel free to check it out.

In short, the main idea in the book is that, there is NO SUCH THING AS A SURE THING! Sure, we would like to believe that we can predict the future, but that's a make believe world. So what has uncertainty to do with Black Swans, you ask?

The Fairy Tale:
Once upon a time, in a land very very far away, there lived a kingdom with many brave and courageous explorers. They journeyed far and wide to all manner of countries and exotic kingdoms. However, in all their journeys, these explorers noted that all swans were WHITE! Naturally, over time, all the people assumed that SWANS MUST ALWAYS BE WHITE! Why? Because collectively, over a period of several centuries, no one ever saw a Black Swan.

Unfortunately one day, there came a stranger who proclaimed he saw a Black Swan in a far far away kingdom. Imagine the laughted and derision he faced... "YOU MUST BE F*CKING CRAZY!" remarked one explorer from the Kingdom. Being astute, the stranger played to the gallery and bet all his money with the disbelievers. Now, several months later, they landed in a strange land called Australia!

HOLY COW BATMAN... I see (& I don't believe it!) BLACK SWANS! OF COURSE, THE STRANGER WALKED AWAY SEVERAL MILLION DOLLARS RICHER AFTER WINNING HIS BET :)

Morale of the story:
Just because you have observed something happen in a particular way for one million times, it doesn't mean that things will NOT turn out differently on the 1,000,001 time.

The Turkey Analogy
Another more interesting analogy is the Turkey Analogy (see chart above). You see, when the turkey gets hatched in January 2008 at the Turkey Farms, he has no idea where he is. He only knows that come each day, there are some benign beings called HUMANS that are there to feed him everyday.

So he becomes more and more contented everyday, since he's being fed every month. Why? Because these HUMANS have fed him so consistently so often, it's a certainty they will feed him tomorrow, right? So, just when he's at his happiest in mid October 2008, oh dear...the HUMAN says "OFF WITH HIS HEAD!". Next thing he knows, the Turkey is being sent to the slaughter house :(

Now, the owner of the Turkey Farms knows well what will happen, since he has all the relevant facts on hand. Unfortunately, the Turkey doesn't and won't realize what's going on until it's too late.

So who are you going to be? The Turkey or the one eating the Turkey?

CONCLUSION:
Beware of the Black Swans! They are the HIGHLY IMPROBABLE EVENTS which have a HUGE REPERCUSSIONS ON THE GLOBAL ECONOMY and on your investments. The September 11, 2001 New York attacks are one of them. My next post will analyze the impact of Black Swans and how to prepare for such contigencies in our investment strategies.