‘Uncertainty is underrated’: Here’s why markets reward bystanders

For many people, uncertainty is something to be avoided or at least mitigated. People often talk more about the negative side of uncertainty than its positive side. There is also a term, loss aversion, that reflects how a loss can feel more painful than a gain of an equal amount can feel rewarding.

However, I have a different view: uncertainty is underestimated. Without it, there would be no surprises, no joy in watching sports, and no average 10% annual return in the stock market over the past century.

All investments involve risk – there is no guarantee of success. Investors can be rewarded for taking the risk of not knowing exactly how things will turn out. If there were no uncertainty, returns would be predictable and there would be no difference between putting your money in a savings account and investing it in the stock market.

Think back to the beginning of the pandemic. At the end of March 2020, the S&P 500 Index was down nearly 20% for the year. However, investors who stayed in the market were rewarded. At the end of 2020, the S&P 500 Index was up 18.4% for the year, a 38% turnaround from March lows. March 2020 was a scary time for almost everyone. No one knew what would happen. Yet even in those dark moments, I had faith in human ingenuity. When people face challenges, they are resilient and work to solve them. Companies are no different. Investing in the stock market means investing in the power of human ingenuity to adapt and innovate.

Because of uncertainty, life is one cost-benefit analysis after another, and we have no choice but to manage risk. At the extremes, some people may try to ignore the risk completely, while others may try to eliminate it. Most of us fall somewhere in between.

We manage risk with our health, work, family and almost every other aspect of our lives – including investing – because while few things are certain, we still have to make decisions big and small. For example, we can’t control the weather, but we can carry an umbrella if it looks like it might rain. And while we can’t predict stock market returns, we can manage the risk in our investment portfolios.

What to avoid

One way to manage risk is to eliminate some of the things you shouldn’t do. When you want to improve your health, you can eliminate fried foods, soda, and sweets from your diet, which can increase the chance of a healthier outcome. It’s the same with investing. Eliminate bad habits, such as trying to predict the unpredictable by trying to time the market or pick winning stocks.

Think about everything that has happened in the last 25 years, including:
• The dot-com bubble.
• 9/11.
• The global financial crisis and the Great Recession.
• The COVID-19 pandemic.

It would be natural to want to time when you exit and re-enter the market. To put the implications of doing this into perspective, consider a hypothetical $1,000 investment in the Russell 3000 Index made in early 1999. This returns $6,449 over the 25 years ending in December. 31, 2023. During the same period, if you missed the Russell 3000’s best week, which ended in Nov. 28, 2008, the value shrinks to $5,382. I miss the best three months, which ended in June. 22, 2020, and the total return is reduced to $4,546. See what I mean?

What should be done

Positive ways of dealing with risk can help you potentially capture the benefits that scientific research has shown us. With health, this means exercising more, getting regular check-ups and eating more fruits and vegetables. With investing, this means making sure our portfolios are diversified across regions and asset classes. While it does not guarantee a profit or avoid a loss, diversification allows us to reduce our risk while potentially capturing market returns.

Since we know that risk is inevitable—and it’s the source of investment return—you want to find the amount of risk that’s right for you. For example, Treasury bills are considered a relatively safe investment asset whose prices do not fluctuate as much as stock prices. However, Treasuries have provided, on average, a lower return than the stock market. These trade-offs can be weighed against your specific needs and preferences, and it’s always good to be prepared for a variety of outcomes. The more committed you are to a philosophy and a plan you can rely on when you’re experiencing the ups and downs of uncertainty, the more likely you are to succeed as a long-term investor.

You are already better at this than you think

You know more about investing than you think you do, because investing is about risk and reward, just like every other part of your life. In investing and in life, some years are better than others, but the important thing is to be able to persevere so that you are ready for what comes next. This is why I see uncertainty as a positive force and believe in people’s ability to find better ways to manage risk. I’ve worked with thousands of investors over my five decades in finance, and I’ve seen how, when they manage risk better, they live better lives. Instead of trying to predict your future, plan, adapt and find the solutions that make the most sense for you.

Not only can you underestimate uncertainty, but you can also underestimate the positive impact of embracing it.

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