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Black Swan Investing: Worth the Risk?

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Ever since Nassim Taleb’s bestseller The Black Swan and the subsequent market crash that ensued, which was clearly a Black Swan (a very rare, unanticipated event), investors and news pundits have been crowing about Black Swan investments and how to get rich off the next unanticipated event.  First, it’s instructive to consider just how to employ some of these strategies and how they might pay off, but it’s also important to consider the likelihood of actually making any investment gains and what you may be sacrificing in doing so.

Black Swan Investing Strategy

The typical strategy as envisioned by Nassim Taleb and others, is to keep most of your portfolio in liquid, ultra-safe assets and use a small portion to invest (gamble) in highly speculative outcomes.  An example might be to hold 95% of your portfolio in cash and Treasury bonds and use the remaining 5% to invest in extremely out of the money put and call options on major market indices.  If you can yield say, 2.5% annually in your risk-free position, you’ll lose 2.5% in your overall portfolio if the market moves sideways when your options expire worthless.  However, during an extreme bull market or precipitous decline, you could make a killing with those out of the money options.  For instance, if during the March 2009 dip, you bought call options on the S&P500 20% or 30% out of the money, or especially, on Financials and Real Estate, you could have made 10 times your investment on the call options which would leave you in the black for several years using this method until the next opportunity arose.

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Another strategy is to take a small portion of your speculative holdings and spread them across various improbable bets.  You might consider say, oil futures contracts at $30/barrel and $150/barrel.  Then, you might consider a Treasury Bond ETF, a broad market ETF and even betting on a further spike in gold prices.  By sprinkling various improbable investment options out there at very low purchase prices, if any one of them hits, it could mean double or even triple digit returns for your portfolio in what would have been an otherwise down market.

Black Swan Investing Risks

The problem with Black Swan Investing is that it is multifaceted.  First of all, everyone’s already talking about it, so many of these esoteric, seemingly far-fetched ideas are already being employed, thus bidding up the price of even far out of the money options.  Next, a Black Swan only comes along every so often.  So, there’s a decent likelihood that you’re going to lock yourself into mild negative gains for the foreseeable future when you may have just been better off sticking with your previous long-term investing strategy.  Finally, Black Swans can’t be predicted.  That’s the whole notion of the Black Swan.  With all the investment moves you conjure up, the Black Swan that rears its head 6 months from now may not be one you ever even imagined (or invested in).

So, while the Black Swan investing idea may sound exciting and profitable, the reality is that for the average retail investor, it’s probably just a red herring.

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