Introduction

Even if you aren’t a history buff, you should have a basic understanding of financial history so that you aren’t surprised by unexpected financial downturns or unexpected inflation. When these downturns or inflation inevitably occur, you will have the courage to stick to your long-term financial plan because you are awaiting the statistically expected outcome of your portfolio. Moreover, whether they are Dutch tulips or blockchain cryptocurrencies, you will recognize and avoid “investment fads”–better stated, “manias”–when they occur.

Limiting your research to just the past 150 years, financial history evidences significant volatility for both stocks and bonds. Using recent history as a rough guide, you should assume that similar volatility will occur again in the future even if you don’t know exactly when it will happen.

Black Swans: Expecting the Improbable

You should also factor the possibility of ‘Black Swans’ into your financial plan. Nassim Nicholas Taleb popularized this concept in his book, The Black Swan: The Impact of the Highly Improbable. ‘Black Swans’ have three attributes:

1. the event is a statistical outlier (e.g. a rare event of large magnitude and consequence);
2. the event carries an extreme impact; and
3. the event has retrospective but not prospective predictability.

Thus, the “improbable, is in fact, highly probable.” The term ‘Black Swan’ is a metaphor, based on the ancient assumption that black swans did not exist because they had not been seen before. Its essence is that people are blind to randomness, particularly those with large deviations. Anticipating the movie, “The Big Short”, a decade later, Taleb said: “Black Swan logic makes what you don’t know far more relevant than what you do know.” The fact that these events are unexepcted is what matters.

As we will discuss in Investment Return, while there have been many black swans in short-term, speculative markets, there have been no black swans in long term investment returns. There have been market corrections, economic recessions, and even depressions. But, over the long term, the U.S. economy has remained resilient, delivering earnings and dividend growth.

U.S. Equities

(Over Exuberance)

1881-83		Stocks lost 36% of their value.
1901	The Panic of 1901	Stocks lost on average x%.
1929	The Great Depression	Stocks lost on average x%.
1937-38	The Recession of 1938	Stocks lost on average x%.
1954-59	The Great Depression	Stocks lost on average x%.
1986-87	Black Monday	Stocks lost on average x%.
1997	Asian Crises	Stocks lost on average x%.
	Savings and Loan Crises
2001	Dot.com Crash	tech bubble burst
2008	Subprime Mortgage Crises	2

U.S. Bonds

(Unexpected Inflation)

1973

OPEC Oil Price Shock / Energy Crisis

in

Summary

Coming soon!

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Updated on February 13th, 2019