When the Improbable Becomes Inevitable, Why Smart Investors Plan for Unlikely Events
“One cannot judge a performance in any given field by the results, but by the costs of the alternative (i.e., if history played out in a different way). Such substitute courses of events are called alternative histories. Clearly the quality of a decision cannot be solely judged based on its outcome, but such a point seems to be voiced only by people who fail (those who succeed attribute their success to the quality of their decision).” —Nassim Nicholas Taleb
The Costly Mistake of Mistaking Probability for Certainty
One of the most damaging behavioral errors investors make is treating highly likely outcomes as guarantees and highly unlikely events as impossibilities. When the improbable inevitably occurs, this mindset causes them to abandon even well-designed investment plans—often at precisely the wrong moment.
A Real-World Case Study: Two Diversifiers Face the Improbable
In my recent Substack columns (October 24 and October 26, 2025), I recommended investors consider two funds that offer compelling diversification benefits: Stone Ridge’s Reinsurance Risk Premium Interval Fund (SRRIX) and AQR’s Style Premium Alternative Fund (QSPRX). (Full disclosure, I am investor in both funds.) Neither has any logical correlation with traditional stock and bond portfolios, nor with each other. The 2022 market provided a textbook example of their value: while stocks and bonds both suffered double-digit losses, SRRIX returned 5.1% and QSPRX returned 30.8%.
But here’s the critical insight that trips up investors: zero correlation doesn’t mean these funds can’t experience losses simultaneously with stocks and bonds. It’s simply not likely—but it is far from impossible.
Quantifying the Improbable
Let’s examine just how unlikely certain negative scenarios are for these funds. Using conservative assumptions—a 2% Fed funds rate, 4% expected risk premium (6% total return), and 12% annual volatility—we can calculate the probability of losses occurring over various timeframes.
Important caveats before we proceed:
These calculations assume normally distributed returns, which simplifies reality. Actual returns often exhibit “fatter tails” with more extreme events than normal distribution predicts.
Multi-year calculations assume independence between years, though returns can show momentum or mean reversion effects.
Expected returns carry substantial uncertainty; the actual premium may differ from our 6% estimate.
The probabilities:
Single year loss (either fund): ~31%
Two consecutive years of losses (either fund): <10%
Three consecutive years of losses (either fund): <3%
Both funds losing in the same year: <10%
Both funds losing for two consecutive years: 0.9%
Both funds losing for three consecutive years: 0.09%
When the Improbable Happened
Now consider what actually occurred from 2017 through 2020:
Year QSPRX SRRIX
2017 +12.1% -11.4%
2018 -12.3% -6.1%
2019 -8.1% -4.5%
2020 -25.0% +6.8%
QSPRX lost money for three straight years (2018-2020)—a 3% probability event. SRRIX did the same (2017-2019)—another 3% probability event. Both funds experienced simultaneous losses for two consecutive years (2018-2019)—a mere 0.09% probability event. The improbable became real.
The Exodus of Impatient Capital
Facing these losses, many investors panicked and withdrew their capital, failing to understand a fundamental truth: low-probability events are virtually certain to occur at some point during a multi-decade investment lifetime. These outcomes should have been anticipated and incorporated into their investment plans. When they materialized, the correct response was to rebalance—buying more, not fleeing in panic.
Those who maintained discipline were handsomely rewarded:
Year QSPRX SRRIX
2021 +25.0% -6.5%
2022 +30.8% +5.1%
2023 +12.8% +44.6%
2024 +21.2% +33.1%
2025* +10.4% +22.4%
*Through 10/24
Four Essential Lessons for Investors
1. Avoid “Resulting”—Judge Process, Not Outcomes
Don’t fall into the trap of equating decision quality with outcome quality. Both SRRIX and QSPRX had sound logical foundations: clear explanations for their expected risk premiums and low correlation with other portfolio assets. Three years of poor performance didn’t invalidate that logic—it simply meant the inherent risks had materialized. When the fundamental rationale remains intact, temporary underperformance is not a reason to abandon ship.
2. Time Horizons Matter—Even a Decade Isn’t Always Enough
Three, five, or even 10 years of poor returns doesn’t constitute sufficient evidence to abandon a strategy if the original investment thesis remains valid. Nothing fundamental had changed with SRRIX and QSPRX during their difficult years. In fact, their expected returns rose. In the case of SRRIX the risks decreased, deductibles increased, and underwriting standards tightened. In the case of QSPRX, the valuation spreads between the long and short positions increased, raising expected returns. Patience and discipline are prerequisites for investment success, not optional virtues.
3. Understand the Risk-Return Bargain
All risk assets will experience extended periods of poor performance. This isn’t a flaw—it’s a feature. If assets reliably delivered positive returns after just a few years, there would be no risk, and therefore no risk premium (or at least much smaller ones). Equities have underperformed risk-free one-month Treasury bills for extended stretches: 1929-1943, 1966-1982, and 2000-2009. These painful periods explain why equities have provided substantial premiums over time—investors demand compensation for bearing that risk.
Long underperformance isn’t a reason to avoid an asset class; it’s a reason to diversify across multiple independent risk sources. Alternatives like reinsurance, long-short style premium funds, private real estate, private infrastructure, and private credit offer valuable diversification precisely because they can perform well when traditional assets struggle.
4. Plan for the “Never Before Seen”
Even events that have never occurred in recorded history can and will happen in the future. Your investment plan must account for this reality in your asset allocation strategy. This is why diversification earns its reputation as the only free lunch in investing—it’s a meal worth consuming in abundance.
The Bottom Line
The improbable is not impossible—it’s inevitable given enough time. Smart investors distinguish between these concepts and build portfolios that can withstand low-probability events without derailing their long-term financial goals. When others panic and sell at the worst possible moment, disciplined investors recognize opportunity and rebalance accordingly. Your investment success depends not on avoiding the improbable, but on expecting it and positioning yourself to benefit when others lose their nerve.
Larry Swedroe is the author or co-author of 18 books on investing, including his latest, Enrich Your Future. He serves as a consultant to RIAs as an educator on investment strategies.