One thing I am certain of is that, in recent years, investors have talked a lot about “rising uncertainty”. While it undoubtedly feels that way, it is not always clear what we actually mean when we say this – isn’t the world always uncertain? Because it is not obvious what this uncertainty consists of, it can be difficult to know what to do about it.

Any conversation about uncertainty needs to begin with the idea of risk. The two terms are often treated as synonymous, but they are different – and that difference matters.

Risk can be thought of as any situation where there is more than one potential outcome, with each outcome carrying a known probability. The classic example of a “pure” risk scenario is rolling a six-sided die. It has six possible outcomes, each with an equal probability of occurring. Crucially, this scenario contains no uncertainty.

Why is there no uncertainty? Because we are sure of the possible outcomes and their associated probabilities. As soon as we lose confidence in what those future paths might be, or how likely they are, uncertainty emerges.

Of course, there are very few things in life – outside of structured games – that involve risk without uncertainty. Human existence is inherently uncertain.

So, if virtually everything is always uncertain, is it ever fair for investors to say that things are becoming more uncertain?

I think it is, and there are two forms of “rising uncertainty” that investors care about:

1. Greater doubt about the probabilities attached to future outcomes. We are comfortable with our model of the world, but are less confident about how likely any given outcome is occur. There is more variability within the model.
   
   
2. Greater doubt about the model itself. It’s not just that the probabilities within our existing framework are volatile; it’s that the framework we use to understand the world may no longer apply.

The first case is what we might call “normal uncertainty”. For example, in a stable economic and political regime, an investor still cannot predict the future with any consistency, but the mental model they apply captures the broad range of outcomes reasonably well.

The second case is “model uncertainty”. This occurs when a political, market or economic regime undergoes a profound shift or shock, leaving us unsure about which model is appropriate in the first place.

Consider an extreme example. Imagine yourself making economic and market projections about a developing country – applying a model based on the structure and stability of a regime that has been in place for fifty years. You can never be certain of the outcomes, but you are comfortable with the parameters. This is “normal uncertainty”. If, however, there is the real possibility of revolution and regime change, you face a more troubling problem: you cannot be confident that the model you are applying will remain appropriate. That is “model uncertainty” – and it is harder to deal with.

When investors talk about “rising uncertainty”, they often mean this latter version (although the two are closely related). Current concerns span multiple areas: the behaviour of the Trump administration, rising populism, a shifting inflation regime, and the changing shape of globalisation. The worry is not simply about calibrating the old model, but whether that model has become flawed or obsolete.

(When I refer to “models”, I do not mean formal, technical models – just the mental frameworks we use to interpret how the world works.)

Although the world almost inevitably feels more uncertain, it is important to remember that financial markets are always inherently uncertain. That is why political, economic and asset-class forecasts are so consistently wrong. We have not suddenly moved from a predictable environment to an unpredictable one. Over the past century we have lived through enormous social, political and economic shifts, and major asset class returns have held up well through these.

That long-term resilience, however, does not mean that such environments are easy for investors. They are not. They create profound challenges – many of them behavioural. If there are genuine concerns about how the world is working, what should we do about it?

Ignore soothsayers

The more uncertain we feel, the more we will be sold products and services promising to navigate it for us. Funds that adapt to all market conditions or research that claims unique insights for a new world will become common. These may seem like appealing antidotes to discomfort, but we should be sceptical. If the future is genuinely more uncertain, adding more predictions is not a sound solution.

Avoid concentration

In an uncertain world, we have less confidence in the path ahead. Concentration by stock, fund, asset class or theme becomes particularly dangerous. If we don’t know where we are going, we should avoid heavy exposure to any single scenario.

Accept the “cost” of diversification

The dangers of concentration can be offset by the prudence of diversification – holding assets that will perform well in different scenarios. This sounds simple but is psychologically difficult, because we dislike holding assets that look like laggards. Good diversification in an uncertain environment means being comfortable owning assets that would have performed better in worlds that did not occur.

Be wary of risk models

Even though we know that “all models are wrong, but some are useful”, we often overweight the “useful” part when it comes to risk models and downplay the “wrong”. This is understandable – in uncertain environments we crave tools that offer comfort – but that comfort is often illusory. This concern is especially acute when uncertainty is more of the “model” variety: a risk framework calibrated to the old world may give precise-looking answers to questions that are no longer the right ones.

Focus on ‘gravitational’ factors

Even in an uncertain backdrop there are elements of investing that tend to work through time – those with a fundamental gravitational pull. These include the yields we receive, the valuations we pay and the cash flows that compound over time. These forces are more likely to work regardless of which future unfolds.

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The world and financial markets are always unpredictable; that is nothing new. There are, however, periods when it feels as though the rules of the game have changed. Whether that proves to be true matters less than thinking carefully about the behaviours required to navigate such environments well.

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My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).