The Myth of the Black Swan

Beyond Buy-and-Hold #93

The market crash of 2008 has been characterized as a ?Black Swan? event. The idea here is that market crashes are so rare that investors dismiss the possibility that they will experience a crash. They come to think of unlikely events as impossible events. Then they fall victim to a Black Swan.


The crash was not a Black Swan event. It was the opposite of that. The crash was 100 percent predictable.

Stock market crashes and investor psychology

There?s a psychological reason why we want to believe that crashes are unpredictable. If it were true that crashes were unpredictable, those of us who lose money in them are off the hook for having invested irresponsibly and of having lost a lot of money as a consequence. The ?Black Swan? explanation for the crash lets us off the hook. Who could have foreseen a Black Swan?

I don?t want to let you off the hook. Not because I am a meanie. I don?t want to let you off the hook because I want you to become a more effective investor. You won?t get there by adopting phony explanations of why you have fallen behind in your efforts to fund your retirement plan.

I know that the crash was predictable. How? Because I predicted it!

And it wasn?t just me. Robert Shiller predicted it. Rob Arnott predicted it. John Walter Russell predicted it. Ed Easterling predicted it. Jeremy Grantham predicted it. John Hussman predicted it. Andrew Smithers predicted it. Cliff Asness predicted it. And on and on.

Investing 101: stocks perform poorly when they rise to insane levels

Those who predicted the crash understand that stocks always perform poorly once prices rise to insanely dangerous levels. That?s the secret. If you avoid stocks or at least go with a low stock allocation at times of high prices, you will earn far higher returns over the course of your investing lifetime while taking on dramatically less risk.

Why is it a secret? Why doesn?t everybody know it?

The truth is, everybody does sort of know it. You know it. You stuck with your high stock allocation not because you didn?t understand that price matters. You stuck with your high stock allocation because, even though you understand that price matters, you don?t want to understand that price matters. So you fool yourself. You convince yourself that you don?t know stuff that you really do know.

How do I know that?

I know because of the reaction I see to my writings on investing just about everywhere I go. I see two reactions: (1) hostility; and (2) indifference. Rarely do stock investors engage me in constructive and positive discussions. It?s emotionally painful for them to do so. I hold up a mirror to investors and ask them to take a look at what they are doing to themselves. I?m tough. Lots of people don?t like facing up to the hard realities.

What passes for investment advice is often sales hype

It?s not that I don?t like you. I like you. I?m tough because it takes a tough man to make a tender chicken. There are lots of ?experts? in this field who are happy to tell you pretty lies. They tell you that there was no way to know that a crash was coming and that you really did nothing wrong and that it is not your fault that your retirement has been delayed by a good number of years.

That makes you happy. And broke. It?s flattery. It?s sales talk. It gets you nowhere. It leaves you vulnerable to losing more money in the next crash than you lost in the last one.

I think we need a new kind of investing advice — straight-talking investment advice. The reality is that we have never in 140 years of U.S. stock market history seen a crash that could not have been predicted in advance. There has never been a serious crash starting from a time when stocks were selling at reasonable prices. On each of the four occasions when prices rose to two times fair value, we saw a crash. It?s not a coincidence. It always happens that way because that?s the only way it can ever happen.

But most people in this field do not see it as being in their interests to tell you.

Investment magazines, TV and even your financial advisor won?t tell the truth

Popular investment magazines don?t want to tell you. Most of the readers of those magazines buy them because they are invested in stocks and want to be reassured that they are doing the right thing. If popular investment magazines told them to lower their stock allocations because a crash was coming, they would cancel their subscriptions. So instead, they tell them what they want to hear. And people lose a big hunk of their retirement money.

The people cited as experts on television don?t want to tell you. People who say that stocks are headed for a crash cause people to change channels. The producers of television shows don?t invite back guests who cause people to change channels. So the experts tell their television interviewers what they want to hear. And the audiences of these shows lose a big hunk of their retirement money.

Your financial advisor doesn?t want to tell you. If he warns you that a crash is coming and one doesn?t come fast, you?ll blame him for losing you money. But if he fails to warn you and you lose your money in a crash, you won?t blame him. He will tell you that it was a Black Swan and the experts on television will say the same and the financial press will say the same and you will let your financial advisor off the hook for giving you bad advice.

If a baseball manager said that his team finished last because of a Black Swan, he would be fired. We have accountability in baseball. If a President said the economy was doing poorly because of a Black Swan, he would lose his reelection bid. We have accountability in politics. If a worker told his boss that he failed to make a deadline because of a Black Swan, he would be fired. We have accountability in corporate America.

We don?t have accountability in InvestoWorld.

That?s why we are all busted.

We need to demand better. Of ourselves. Of the investment magazines. Of the experts on television. Of our financial advisors.

It?s not Black Swans doing it to us. It?s us doing it to us.

Rob Bennett has written about stock picking for indexers. His bio is here. For background on the Big Fail of Buy-and-Hold and on the need to move to Valuation-Informed Indexing, please check out the ?About? page at the ?A Rich Life? blog.

( Photo from Flickr by Helico )

2 Responses to The Myth of the Black Swan

  1. Very good information. I believe you have to have someone you trust handle your retirement account. I’m lucky I have someone.

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