Black Swan Bias: Rare Events Don’t Happen Everyday

Today, let’s talk about Black Swan events. More precisely, something I call the Black Swan Bias. A Black Swan is a rare event that comes as a surprise, has a major impact, and is often inappropriately rationalised with the benefit of hindsight later.

By definition Black Swans don’t occur very often. Common events have a high probability of occurring, and this is something we often forget. This is Black Swan Bias. Let me illustrate with an example.

Do you remember the last time you had a headache or back pain or flu (or just about any ailment) and you went online to diagnose and search for a possible cure? There’s a good chance you stumbled on something like, “…in rare cases, it can be a sign of cancer.”

Even though this information is enough to trigger a mini panic attack, this is a false alarm. According to the law of averages, common events have a high probability of occurring than rare events. The headache is due to lack of adequate rest and not a sign of cancer.

There’s some wisdom in the saying, “Lightning never strikes (the same place) twice.” Black Swan events maybe rare but the distortions caused by them don’t disappear for a long time. For example, the dotcom crash in 2000 was the biggest since the crash of 1929, and the lessons learned from it defined and distorted almost all thinking about technology in the next decade.

Suddenly bold moves were replaced by incremental advancements. Moving fast with breakneck speed got replaced by staying lean and avoiding hypergrowth. Slowly these lessons became dogma. Those who ignored them were presumed to invite an eventual doom (the lightning).

Something similar happened after the financial crisis of 2008. Even a slight tremor in the market and pundits started predicting the next crash is nigh, and it’s even bigger this time. They discounted the odds of average recession, an average bear market, or average growth.

At every corner, they started seeing extremes.

There’s an interesting paradox here. The reason we pay so much attention to the 2000 crash, or the 2008 crash is because they are rare. But paying so much attention to them makes us overweigh the odds of them happening again. We start discounting the odds of the common in favour of the rare.

Black Swan events shape our world. In both business and investing, it’s a good practice to be on the lookout for them. But respecting the outlier and finding them in every nook and corner are two different things.

You want to be aware of the risks of starting a startup. 9 out of 10 startups fail within the first few years. But you don’t want to be someone who thinks every other hiccup is a sign of the impending doom.

The whole wisdom of Black Swan events is that we underestimate their impact. But overestimating can be just as dangerous.

Accurately diagnosing a serious business risk isn’t an accomplishment if you made 100 dangerous false-positive diagnoses before it. Accurately predicting a financial crisis isn’t an accomplishment if you spent a decade before it falsely predicting doom.

The takeaway is something that sounds blindingly obvious but we often forget: Rare events are rare, so we should expect more common events to have a higher probability of occurring.

Average events that go unnoticed—the little lack of minerals in the diet, the accumulation of tiny debt in personal finance, the slow churn of customers in a business—have a compounding effect in the long run.

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