Uncertainty and fear of the unknown drive much human behavior. That fear of walking down a dark alley is rooted in millions of years of human evolution. In the 21st Century, we try to mitigate those primal fears by increasing our knowledge and sense of control. Such efforts explain why insurance and lobbying are multi-billion-dollar industries.
Yet, despite our attempts to control or foresee it, the future remains unknowable. Nowhere is that perhaps more true than in investing, where a brilliant idea may not necessarily translate into a lucrative one. But all successful investors have learned how to embrace uncertainty.
In an excellent essay titled “Investing in the Unknown and Unknowable,” Harvard economist Richard Zeckhauser argues that conventional financial wisdom does not apply in what he calls UU (unknown and unknowable) situations.
Some of the big lessons we learned from Dr. Zeckhauser’s essay include: (1) Make investments when your upside is larger than your downside; (2) Beware of asymmetrical information (i.e., when somebody might know something you do not); and (3) Make a move when the right combination of skill and expected financial payout stack the odds in your favor.