Tail risk refers to devastating events that are expected to happen very rarely, like a so-called “1,000 year flood.”
If you took Statistics in high school or college, you probably remember the old bell curve. The taller section in the middle contains events that happen all the time. Further out in either direction and you get events that happen less frequently. Then you get the “tails” on either side…and these are events that are outside 3 standard deviations. In other words, tail risk refers to an event that (allegedly) has a 3 in 1,000 chance of happening.
Part of the trouble in the world of investment and economics is these events have been happening far more frequently than expected, which is probably cautionary about having too much faith in standard economic models.
Traditional buy-and-hold investors really can’t avoid tail risk. Just think of how many portfolios got killed in the dot-com crash of 2000-2002 and the "Great Recession" of 2007-2009...and I wouldn't necessarily even classify either of those as "tail" events. You have to either (1) be tactical with strategies like increasing cash weighting, using protective stop-loss orders, hedging with options, or (2) try to take advantage of tail risk by holding financial instruments that will actually benefit when everything comes unhinged. Or you could always do some of both, of course.
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