By Gary Brooks, CFP®
Uncertainty is generally unwelcome. It clouds decision making and halts confidence. And it is always present — the crisis du jour is constant. We could address this topic every month and it would be timely.
But uncertainty is not all negative.
The uncertainty of stock markets provides much of the reason for higher long-term returns than you can receive in many other investments. If returns were certain, they certainly would be lower than stocks have generated historically.
Just as important from our viewpoint, uncertainty also increases the need for analysis and planning. It provides a reason to be thorough in research and specific in determining the right investment portfolio for any given person based on their goals and comfort with market fluctuations.
Seth Klarman, one of the most successful value investors of the past 20 years, authored a paper in the midst of the financial crisis in 2009 titled The Value of Not Being Sure. One passage in particular seems fitting to keep in mind as the situation in Greece grabs headlines along with uncertainty about whether or not the U.S. economy is strong enough for the Federal Reserve to raise short-term interest rates.
Klarman wrote: “To be sure, uncertainty breeds doubt, which can be paralyzing. But uncertainty also motivates diligence, as one pursues the unattainable goal of eliminating all doubt. Unlike premature or false certainty, which induces flawed analysis and failed judgments, a healthy uncertainty drives the quest for justifiable conviction. Always remembering that we might be wrong, we must contemplate alternatives, concoct hedges, and search vigilantly for validation of our assessments.” (More highlights of the paper here).
When we build financial plans we have no choice but to make a series of assumptions that are certain to be imprecise. But this uncertainty forces us to be very conscious of the legitimacy of our assumptions and how they may impact financial security. Similar vigilance goes into our review of investment choices and how they work together to align with the financial plan.
We know that markets will zig and zag; stocks and bonds will alternate relative attractiveness. But without control over the timing of these shifts in market favor, we need to be clear about how people feel about uncertainty. As David Booth, founder of Dimensional Fund Advisors puts it: “Markets will go up and down. Invest in a way that you can accept it. Don’t put enough at risk that its fluctuation will make you too nervous.”
It’s important to remember that often, the uncertainty which may make you nervous is not actually all that important. As Eddy Elfenbein of the Crossing Wall Street newsletter points out, “The market rises by about 1/30th of a percent each trading day. The volatility each day is about 1%. So that’s saying each day the noise is thirty times greater than the value. Just think about that.”