How to handle uncertainty when investing

Investing is just a string of grey-area questions. Here's how to buy and sell when you don't have all the answers.

Let’s say I came to you with a strange financial offer. Which would you prefer: (1) a guaranteed $30, or (2) an 80% chance of winning $45 and a 20% chance of going home empty handed.

If you’re like most people, you’ll prefer the sure gain of $30 despite the more favourable expected value built into the second deal (that is, 80% X $45 20% X $0 = $36).

Evolution has saddled us with an overwhelming distaste for uncertainty and a preference for predictable situations, but that can be a big drag on your investment returns.

The problem with this certainty effect is that it steers us towards only the safest stocks, which, unfortunately, tend to offer the lowest yields precisely because everyone else is buying them too.

The certainty effect is a close relative of information bias – our tendency to believe that the more information we acquire, the better our decision will be, even if the additional information is irrelevant. If you find it hard to pull the trigger when buying or selling, and justify it by saying to yourself ‘I’ll give it a couple more days to see what happens’, you may be falling for this cognitive no-no.

The real problem here isn’t the feeling of uncertainty itself; it’s the paralysis or misdirection that follows. But there is a solution.

Take a deep breath

The first thing to do is to accept that uncertainty is part and parcel with investing. As Warren Buffett said in a 2011 CNBC interview: “The world is always uncertain. The world was uncertain on December 6th 1941, we just didn't know it ... The world was uncertain on September 10th 2001, we just didn't know it ... Now the question is, what do you do with your money? … If you leave it in your pocket, it'll become worth less over time. That's certain.”

Embracing uncertainty doesn’t mean you should throw all your research out the window and just go with the flow. It means you need to recognise that you will never have all the facts; you will always be making decisions in an unpredictable environment – but, at some point, you’ll have to take action anyway.

Given this, it’s important to focus on your temperament and investing practices, which you can control, rather than the outcome of any one purchase. You can’t guarantee that XYZ will be a multi-bagger, but you can save a little more each month and refuse to make same-day buy or sell decisions when emotional.

Finally, practice ‘negative visualisation’ as Oliver Burkeman, author of The Antidote: Happiness for people who can’t stand positive thinking put it.

We’re currently in one of the longest unbroken bull markets in history, so it’s natural to feel uncomfortable and wonder ‘when’s the next crash?’.

However, rather than attempt to time the market or reassure yourself that everything will turn out well, try to imagine what things might look like if your investments did go belly up. How will you really feel if your portfolio halves in value? What steps will you take to stay the course and find new opportunities? Picturing the worst-case scenario – and how you will make it through – will help keep you level-headed when the next market panic arrives.

To get more insights, stock research and BUY recommendations, take a 15 day free trial of Intelligent Investor now. You can find out about investing directly in Intelligent Investor portfolios by clicking here.

Related Articles