Uncertainty… Who Needs It? Apparently, We Do.

Q3 | August 2020

Topic: Investments

Alexandra Jemetz CIM

August 12, 2020

Image used with permission: iStock/AnnaPustynnikova


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Uncertainty… Who Needs It? Apparently, We Do.

Q3 | August 2020

“Uncertainty and affect are fundamental and interrelated aspects of the human condition. People have a propensity to simulate negative outcomes, which result in a propensity toward negative affective responses to uncertainty.” (1)

It is not exactly a revelation to say that uncertainty contributes to stress. In “normal” times – take 2019, for example – three common sources of stress stood out. According to the American Psychological Association:

  • More than a third of Americans cite unexpected expenses as a source of stress related to money.
  • Nearly a third of Americans say economic uncertainty is a source of stress when thinking about the economy.
  • When it comes to health-related issues, around two-thirds of Americans cite uncertainty about the future as a source of stress.(2)

Money, the economy, health. Reading this through a 2020 lens, it is no wonder current stress levels are at historical highs.

Uncertainty is inevitable and the stress it causes is often viewed as unwelcome. However, a study conducted in 2016 by researchers at University College London suggests that uncertainty-induced stress may not be that bad for you. Their conclusion instead was that “stress may inform judgements of risk.”(3)

In the study, participants played a computer game in which they had to guess whether the rocks they turned over had snakes under them. If they found a snake, they would receive a mild electric shock on their hand. The program was coded so that the odds of finding a snake changed over time, thereby changing the levels of uncertainty. The model allowed the researchers to predict participants’ stress levels based not only on whether they actually received shocks, but also on how much uncertainty they had about getting shocked. “Our experiment allows us to draw conclusions about the effect of uncertainty on stress. It turns out that it’s much worse not knowing [if] you are going to get a shock than knowing you definitely will or won’t”, explains lead author Archy de Berker. The results showed that participants who had a 50% chance of receiving a shock were the most stressed, while the subjects with 0% or 100% chance were the least stressed. “People whose stress levels tracked uncertainty more closely were better at guessing whether or not they would receive a shock”.

They explain further using real-world examples such as applying for a job, waiting for a train or expecting your medical results. “The most stressful scenario is when you really don’t know. It’s the uncertainty that makes us anxious,” says co-author Dr. Robb Rutledge. “From an evolutionary perspective, our finding that stress responses are tuned to environmental uncertainty suggests that it may have offered some survival benefit,” explains senior author Dr. Sven Bestmann.

What this Means for Investors

From an investing viewpoint, uncertainty manifests itself in the concept of volatility, typically measured by price fluctuations in security prices. It captures investors’ jitteriness as they react to news of events that lead to unpredictable outcomes. But, there is a factor that can undermine the perception that uncertainty categorically increases risk, and that is the passage of time. Equity investors, theoretically, should be able to handle short-term volatility because they should be certain that equities will have positive returns over time. Anyone invested in capital markets pretty much has to believe that humans will consume goods and services in the future and companies will continue to exist in order to profit from those activities. Otherwise, people would be investing only in things such as art, stamps or gold bullion, or – at worst – stuffing money under their mattresses.

What Nexus has Learned

We’ve learned a lot in our over thirty years in this business. Two key takeaways stand out:

One – don’t stray from a proven process.

Perhaps being burned in the past does indeed improve judgement and decision-making ability. Nexus has been in business since 1988 and has applied the same investment approach through the crash of 1989, the late ‘90s bear market, the 2002/03 tech wreck and the global financial crisis in 2008/09, with a keen focus on long-term growth and capital preservation. We firmly believe in this approach and that market timing does not work in the long run. Uncertainty is the very reason to have a portfolio that has elements of growth potential for the ups and defensive characteristics for the downs. Having this tried-and-true long-term strategy helps us stay the course and avoid doing something just for the sake of looking busy. Most investors who tried to time the market crash in March by moving to a more conservative positioning paid a dear price as the market bounced back with whiplash speed.

Two – an important foundation clients can rely on is their financial plan.

Nexus takes a conservative approach to planning, using moderate return assumptions. These return assumptions are based on what we think is a conservative estimate of future long-term returns. These estimated returns are meant to “average out” over time. That is, capture in the plan what in reality will surely include both significant up years and severe market downturns. Even so, when real life looks like 2020 – the worst global pandemic in a century causing the most rapid market and economic decline in as many years – it is challenging for any investor, even the most disciplined one, to “keep calm and carry on”. However, a client that has completed a proper plan can put a poor year like 2020 into perspective and reduce the negativity associated with it. These clients can remain focused on managing the controllable aspects of their plan, such as their spending and savings, and not stress about the uncontrollable ones, like each individual year’s returns. These clients can take comfort that, even in a bad return year, the good and the bad years will average out and they will continue to move towards the longer-term goals outlined in their plan.

Conclusion

Although uncertainty is often viewed as negative, it’s not always the case. Removing uncertainty from activities such as watching sporting events, gambling or reading scary books also removes some of the pleasure associated with these activities. This suggests that it could be the uncertainty that people identify as problematic that causes stress, not that all uncertainty does.

So, go ahead, open up that box of chocolates and pick one. Not knowing what’s inside may actually help you make better decisions in the future. In the meantime, you may just have to learn to like Pink Nightmare cream filling.

(1) The Relationship Between Uncertainty and Affect, Eric C. Anderson,  Nicholas Carleton, Michael Diefenbach and Paul K. J. Han, Frontiers in Psychology, 12 November 2019.
(2) Stress in America Survey, American Psychological Association, October 1, 2019.
(3) Uncertainty can cause more stress than inevitable pain, ScienceDaily, 29 March 2016.

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