The Prudent Investor Blog

Risk Versus Uncertainty: 3 Things a Prudent Investor Should Know

Posted by Benjamin Coakley on Wed, Aug 01, 2012 @ 11:39 AM

As an independent Registered Investment Advisor with offices in both Summerville, South Carolina and Asheville, North Carolina, Waypoint isprudent investor, summerville, asheville ever aware of uncertainty.  This is the uncertainty of Mother Nature.  This is particularly true during hurricane season in Summerville.  Being twenty miles from the coast, we have learned to be vigilante of the tropics from June until November.  If you become complacent, Mother Nature will send you a reminder of why this is not a good idea.  Hurricane Hugo in 1989 was that reminder for many South Carolinians.  In Asheville, freak blizzards in the winter can reak havoc.  In fact, two winters ago, one of our advisors got pretty comfortable working from home (when he had power) because he was unable to get down the mountain for days even weeks at a time.  So living with this natural uncertainty is a way of life for us at Waypoint.  Uncertainty also exists in the financial markets.  The past couple of years have been very uncertain with the housing market crash, debt issues in Europe and many other factors.  This has wreaked havoc in the financial world.  It is very imporant to know that there is nothing a prudent investor can do about uncertainty whether the financial or natural kind.

Many investors think that uncertainty and risk are one and the same.  However, they are not.  Risk can be mitigated, but uncertainty cannot.  A great example of risk is life insurance.  Insurance companies have actuaries that research and calculate the probability of a particular person that applies for life insurance dying this year.  This allows the company to assign a risk to that person and, therefore, know how much premium to charge them for the insurance.  There are many risks associated with any investment portfolio that, if managed effectively, can result in greater sums of money after a set time horizon.

The tips are imperative to understand when making decisions based on uncertainty and risk:

  1. Understanding what is uncertainty and what is risk is important: Answering the question "Is it outside of my control?" can help determine uncertainty or risk.  If the answer is yes, then it is uncertainty. If the answer is no, then it is risk.  Once you determine it is risk, then you can then begin to formulate a plan to manage that risk.
  2. Without uncertainty there can be no risk: A corollary is that the more uncertainty, the higher the risk of making a poor decision.  When the financial markets are experiencing high volatility due to increased uncertainty, billions of dollars are lost by investors (or gained by brokers)  due to poor emotional decisions.
  3. Consistent diversification is the key: Every investor has heard that diversification reduces risk.  However, true diversification is rarely ever attained.  The reason is that people consistently make changes to portfolios (market timing or stock selection) either with or without the advice of an investment professional.

Life in itself is uncertain.  No one is guaranteed the next second, minute, hour or day.  This is true in the financial world as well.  Once, investors admit to themselves that there is absolutely nothing anyone can do about uncertainty, then they can get down to the business of investing.  Investing is about managing risk in a portfolio.  And, as this blog post discusses, this is possible.  How prudent investors manage risk can make the difference between reaching accumulations goals or not.

Tags: prudent investor, risk, uncertainty, summerville, asheville