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How Americans can prepare for black swan events

How Americans can prepare for black swan events
© BRYAN R. SMITH/AFP/Getty Images

The COVID-19 pandemic is considered a “black swan”— a name given to events that are inherently unpredictable and highly improbable. But while the current global pandemic represents an unprecedented crisis, it’s not the first black swan event that’s roiled the markets. A bursting dot-com bubble, the 9/11 terror attacks and the Great Recession all fall into this category. That makes coronavirus the fourth black swan event since the turn of the century alone.

From an investing perspective, the fallout from coronavirus is hard to miss. The longest bull market ever, which saw stocks march higher for over 10 years, has come to a screeching halt. Last month, the S&P 500 posted its worst day since 1987. The U.S, which has more COVID-19 cases than any other country in the world, has lost 10 percent of its workforce in a mere three weeks. Retail sales posted their biggest plunge in the almost three decades they’ve been tracked.

A common denominator of black swan events is that they come without warning, meaning average investors often don’t recognize their seriousness until the time to act has passed. While history is often revised to make these events seem obvious in hindsight, trying to predict them is nearly impossible. Nevertheless, investors can proactively equip their portfolios to handle tremendous turmoil, minimizing the impact of black swans in the process. 

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Diversify beyond stocks

When the market is chugging higher, as it was during the recent record-setting bull run, investors are prone to boundless optimism. They pour all of their money into stocks because they don’t want to miss out on gains. Such optimism evaporates quickly when a black swan hits; stocks tumble and tumble fast. The global pandemic didn’t just cause a downturn; it caused the fastest start to a bear market ever.

Diversifying your portfolio with defensive assets, even when the market is strong, is the best preparation for a future black swan. While bonds are usually considered safe assets, corporate bonds have plummeted alongside stocks in the wake of coronavirus.

Instead, Treasuries seem to offer the most reliable protection against black swan events, since they are backed by the U.S. government. Additionally, precious metals like gold and silver can also help investors endure a stock market downturn, as we are experiencing now.

Watch for buying opportunities

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Letting your animal instincts take over is dangerous during bull and bear markets alike. In the former, as mentioned, investor greed leaves many all-in on stocks and overexposed. When things turn sour, fear leads to indiscriminate selling.

While the coronavirus has undoubtedly stifled the economy — and the worst of the correction may not be over — there’s a good chance this sell-off has been an overreaction, as is often the case with dramatic downturns. Fear, a need for liquidity, short sellers and myriad other factors combine to drive even resilient companies further and further down.

As such, diversifying your portfolio should mean holding not just defensive assets, but cash. These cash reserves will offer investors — at least those able to keep their cool — a way to take advantage of an over-correction.

Cash can make investors feel like they’re watching from the sidelines during a bull market, and how much money you put in cash needs to be weighed against the opportunity cost of its yield (or lack thereof). But while you’re making that cost-benefit calculation, remember that cash is king during a downturn — and during a black swan event in particular.

The bottom line

Black swan events offer an important reminder: having defensive assets is always a savvy move — especially for older investors who have less time to recover dramatic losses. It’s unclear whether the market will bottom anytime soon and substantial damage has already been inflicted. Still, investors cannot make decisions on heightened emotions during good times or bad. Instead, they can and should proactively prepare for future black swan events through the tools outlined here and proper financial planning.

Individually, black swan events are spontaneous and unique. But what they have in common is their unpredictability and the havoc they wreak. By investing in defensive assets and keeping cash reserves, investors will be better equipped to deal with current and future catastrophes. We should all prepare for black swan events even though we cannot predict them.

David Flores Wilson, helps Gen X and Gen Y professionals and business owners in New York City achieve financial freedom. Named one of Investopedia's 100 Top Financial Advisors of 2019, he is a Senior Wealth Manager for Watts Capital and Writer/Editor for Planning to Wealth. His financial guidance has appeared on Yahoo Finance, MSN News, CNBC and InvestmentNews.