Adversity And Your Portfolio

In a recent study, Stanford University researchers examined mindsets’ effects on stress reactions. Eric N. Smith, Michael D. Young and Alia J. Crum, “Stress, Mindsets, and Success in Navy SEALs Special Warfare Training.frontiersin.org (15 January 2020).

The researchers questioned whether mindsets are beneficial in environments of extreme physical and mental stress by studying Navy SEALs candidates undergoing training.

They found that the candidates who viewed stress as a positive – those possessing a stress-is-enhancing mindset – performed better than the candidates with a negative attitude towards stress – those with a stress-is-debilitating mindset.   

The researchers’ findings showed that the candidates with a stress-is-enhancing mindset demonstrated greater persistence through training, faster obstacle course times, and fewer negative evaluations from peers and instructors. On the flip side, they also found having a stress-is-debilitating mindset was detrimental to candidates’ success.

In investing, few events are more stressful on a portfolio than a black swan event. What is a black swan event?

In the world of investing, a black swan event is an unpredictable event that is beyond what is normally expected of a situation and has potentially severe consequences. Black swans wreak the most havoc and devastation when people least expect it.

Three notable black swan events have occurred in the past 22 years:  the dot-com bubble, the Financial Crisis, and COVID-19.

The markets took a substantial tumble – devastating portfolios in their wakes in all three events. For example, the Nasdaq dove more than 70% when the dot-com bubble burst, the S&P 500 lost more than 50% from its high during the Financial Crisis, and more than 33% in the early days of the pandemic.

How a portfolio responds to the extreme stress of a black swan event begins with the investor and the investor’s mindset.

Suppose an investor’s mindset is one of powerlessness in the face of adversity. In that case, more than likely, that investor’s portfolio will be powerless and at the mercy of the whims of the markets in the face of adversity – tumbling right along with public markets (think 33%, 50%, 70% drops). You could characterize those portfolios as vulnerable or fragile, but not all portfolios and investors are vulnerable.

While some investors and their portfolios shrink in the face of black swan events, others have different mindsets. Instead of viewing black swan events as portfolio killers, some investors view them as portfolio enhancers.  

In his book “The Black Swan,” author Nassim Nicholas Taleb explores the black swan phenomenon and how an investor can prosper instead of suffering from a black swan event. At a time of economic uncertainty and the possibility of another black swan lurking around the corner, the book is intended to help investors navigate volatility, avoid common mental pitfalls and prosper from black swan events. edelweissmf.com

Here are some of the significant takeaways from Taleb’s book:

  • Unlikely, large and unexpected events dominate many aspects of our lives.
  • It is like humans to focus on the likely and probable.
  • We all see patterns and causality where, in reality, there are a lot of random nesses.
  • The past is not a reliable predictor of the future.
  • One should not waste their time trying to predict extreme events. Instead, one should adjust to the black swans.
  • Black swans can also be positive and offer huge opportunities.
  • To capitalize upon positive black swans, one must constantly be on the lookout for opportunities and should not hesitate to grab them.
  • You are the only one who can control your destiny. The way you react to an event will determine its impact on you. Take control of your life.

My main takeaway from Taleb’s book is that we don’t have to be victims of the next black swan event or economic disaster. We could profit from the next disaster if we have an opportunist mindset. The key is to mitigate all the factors out of our control to minimize volatility and uncertainty.  

If you want to know how to prosper from a black swan event, look to the investors who have prospered from black swan events in the past. Look to ultra-high-net-worth individuals (UHNWIs) who have fortified their portfolios from adversity in the past and profited from adversity.

How do UNHWI’s strengthen their portfolios to profit from adversity?

Here are their foundational investing tenets:

  • Take the emotion out of investing. Seek private assets insulated from crowd behavior and Wall Street volatility through illiquid long-term investments.
  • Invest in assets with inelastic demand insulated from the effects of recessions and inflation.
  • Seek passive income that can compound to create multiple streams of passive income to insulate against potential job loss or income reduction. Income-producing private companies and commercial real estate are ideal for generating passive income.
  • Rely on numbers, analytics, and underlying economic fundamentals when making investment decisions.
  • Invest in assets with a track record of success.  

The economic road ahead could be bumpy – one fraught with adversity and challenges. With inflation raging and recession already on our doorsteps, the only certain thing is uncertainty.

As an investor, you can do one of two things: shrink in the face of impending doom, or you could batten down the hatches and fortify your portfolio to prosper during the next downturn.

It’s possible to profit from a black swan event. It just takes the right mindset.


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Logan Freeman

Building generational wealth with alternative investments