This is not a new topic to this blog. I have discussed various specific aspect of uncertainty before, but today’s post will handle the more generic aspects of uncertainty. In addition we’ll touch on how to best manage uncertainty for your own sanity and for the sake of being prepared.
What is Uncertainty
Uncertainty at it’s most basic is not knowing what will happen next. A feeling of uncertainty is often accompanied by doubt, hesitation, or even anxiety. I have written before that humans tend to be adverse to change, well uncertainty is just the harbinger of change. You know or suspect it is coming but not when or potentially even what will arrive.
I wrote a few months ago about market uncertainty. With a million and one articles floating around postulating the market is in a bubble it could cause anyone anxiety and uncertainty on what is to come. And yet not much has changed since that post in March. Those articles are still popping up everywhere, and the market is still up, despite a recent short lived correction. In that article I gave very specific advice to what to do in the case of market uncertainty, stay the course of your financial plan. But how did I come up with that advice, and why did I think it was important to deliver that post? I’m obviously not that good with click bait titles so I must have had another motive for focusing on that specific topic.
Determining what Types of Uncertainty to Pay Attention Too
Let’s start out by saying not all types of uncertainty are worth your time. You could worry or plan for nuclear war until the cows come home, but the odds are your planning will come to not. Even if the event occurred, which thankfully is a moderate to low likelihood in my opinion, the odds that your preparations will allow you to lead any semblance of a normal enjoyable life are not high. So most do not worry about it.
What are the Odds of a Crash
Conversely the odds of a stock market crash or dramatic increase in unemployment are much higher. These things happen once every decade give or take. (though remember I do not condone timing as a measure of recession due date) This means the probability of them occurring in any given year is significantly higher then nuclear war or a meteor hitting your house. In fact one could label the probability as 100% likely given enough years. As such unlike a doomsday prepper’s fantasy of zombies, a market drop is a legitimate concern.
But what of the Impact
Still not everything that occurs has a huge impact. Assume it is 90% probable it will rain next week. But given I park in a garage at home and carry an umbrella in my car do I really have anything to fear? The worst that can happen is I get a little wet. So I don’t worry about it. A market crash however can have big impact to those that depend on their returns. Especially those who need their money now like retirees. The sequence of returns can make a difference on whether you run out of money or coast through retirement. So the impact to a market crash is potentially large.
Where Impact and Probability Meet Defines Planning Need
The combination of impact and probability define what you should plan for. Those items that are high impact and high probability need to have either avoidance or mitigation plans. Why? These are the most likely to cause you problems. In the quality and project management world we use something called a probability/risk matrix to determine what we will plan around. You take the probability multiplied by the impact and you put in place contingency plans around those items with the highest result. By this definition market crash has one of the highest results, so thus it’s important to plan for it. It was also important to write about for that reason.
But How Do You Plan To Mitigate
The best way to plan for high results is by learning what happened in similar circumstances. There is an old saying from the bible, “There is nothing new under the sun”. There are always analogous situations somewhere in the past that can give inclination into what might happen and how you should consider preparing.
Planning to Mitigate the Market
This is especially true with the market. I cringe every time I hear someone say something about the rules of the market changing or this time it will be different. The reality is, it will be different, but it will also be the same enough that you could have studied the past and been prepared for most eventualities. The market will still crash and recover with cycles, and we still will not be able to predict those cycles with any accuracy. In other words the best course of action will be as it always is, do not attempt to time the market.
Mitigating Other Risks
I have spent much of this post focusing on the market as a metaphor. But my same analogy applies to any and all risks in your life. Some other basic examples:
- You can weigh your risk of job loss based on the stability of your company, your role, and the economy. The likelihood is unique to your career. The impact is higher earlier in your career and lower later. Your mitigation is at first emergency funds and later financial independence. How much you need depends on the probability.
- You can weigh your risk for health, liability, or auto issues. Your family history and exposure plays some aspect, but poor health is almost inevitable these days and lawsuits are a dime a dozen. The impact meanwhile can be huge which is why we always recommend buying insurance.
There are many more examples I can give here, but the key is they are both at least moderately likely and significant impact. Which brings me to the point of this post. It’s absolutely essential to plan for items with high likelihood and impact. But just as important is to not obsess over the things with low probability or low impact. These will just lead to stress, anxiety, and less happiness. Focus on the things that will have a high impact on you or your family and that are likely to occur. Filter out the rest of the noise.
Do you have any unique risks? Tell us about them in the comments.