David Booth—the Executive Chairman and Co-Founder of Dimensional Fund Advisors—recently wrote an article entitled “Uncertainty is Underrated.” In this episode of Best in Wealth, I will read this intriguing article and share why I agree that—while it sounds scary—uncertainty has a positive impact on our lives.
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Outline of This Episode
- [1:23] The blue cruise function on my F150
- [3:11] David Booth’s article on uncertainty
- [10:36] Life is one cost-benefit analysis after another
- [13:22] How to manage risk: What to do (and not do)
- [19:31] Why you need to know the basics about uncertainty
Uncertainty is why we see stock market returns
Without uncertainty, there would be no 10% annualized return on the stock market. How?
According to David, “If there was no uncertainty, returns would be predictable and there would be no difference between putting your money in a savings account or investing it in the stock market.” Risk makes potential rewards possible.
When you have money in your savings account and it is earning interest, it is
certain that you will receive interest payments. The stock market is different. It is a roller-coaster. The S&P 500 was down 18.5% in 2022 and up 26% in 2023 (which is not abnormal).
Uncertainty simply means that we do not know—from day-to-day, week-to-week, or month-to-month—what those returns will look like. Everyone is guessing.
Over time, the stock market has delivered a 10% return. The reason we see a higher rate of return in the stock market is only because of the uncertainty.
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Life is one cost-benefit analysis after another
What is loss aversion? It is the premise that a loss can feel twice as painful as a gain of an equal amount. It might be one reason why uncertainty is underrated. An 18% drop in the stock market feels twice as bad as when the stock market goes up 18%.
David points out that “Because of uncertainty, life is one cost-benefit analysis after another, and we have no choice but to manage risk.” We cannot ignore it or eliminate it entirely, nor would we want to. But what we must do is prepare for it.
And humanity is no stranger to uncertainty. We have to make choices every day and those choices are how we manage risk. David points out that we cannot control the weather. But if it looks like it is going to rain, we might carry an umbrella around. The cost is the weight of the umbrella but the benefit of that cost is staying
dry.
He shares that “When it comes to investing, you cannot manage stock market returns, but you
can manage the risk you take.”
How to manage risk: What to do (and not do)
So how do we get better at managing risk?
- What not to do: Do not try to predict the unpredictable by trying to time the market or pick winning stocks. Many of us struggle with the desire to time the market. But we cannot time it. When we try, it is a loser’s game. You will likely leave a lot of money on the table.
- What to do: Diversify your portfolio to reduce risk and capture return. Secondly, figure out the amount of risk that you are comfortable with. You should invest and be prepared for a range of outcomes.
When you have a plan that you can depend on—and experience uncertainty—the more likely you are to succeed long-term.
We have all been managing risks and rewards our entire lives. Some years are better than others. But we stick around to see what happens next. That is why uncertainty is positive.
David’s final thoughts drive home the point of this entire episode: “The key is to develop a philosophy, define your goals, and steer toward them, adjusting along the way. You might not only be underestimating uncertainty, but you may be underestimating the positive impact of embracing it.”
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Podcast Disclaimer:
The Best In Wealth Podcast is hosted by Scott Wellens. Scott Wellens is the principal at Fortress Planning Group. Fortress Planning Group is a registered investment advisory firm regulated by the Securities Act of Wisconsin in accordance and compliance with securities laws and regulations. Fortress Planning Group does not render or offer to render personalized investment or tax advice through the Best In Wealth Podcast. The information provided is for informational purposes only and does not constitute financial, tax, investment or legal advice.
