We live in an uncertain environment. Nothing we learn truly teaches us to deal with uncertainty. Even very rational people behave irrationally in an uncertain environment. Here are some ideas that help me personally deal with uncertainty.
Show sport spirit
Sometimes we win and sometimes we lose, no matter how smart we are. If we give 100% to win but take the losses like gracefully in sports, we are in a good place. I saw a TV show where one of the experts compared the actual scenarios to letters. I will take it a step further:
W – The winners’ handling crisis. There is a crisis (fall), corrective action (rise), delayed response (second fall) and recovery (final rise). Typically we and hire than we started.
V – Easy victory. The crisis generates some change, which works.
U – Uneasy victory. It takes time to come up with a proper response, but eventually, we are successful
Y – Why we believe in a higher power. Occasionally we fall miserably, but then find an unexpected help that provides a huge recovery. Usually, such a result characterizes irresponsible gamblers with a lucky break. I would say ominous…
O – Oscillations. Constant ups and downs in a small channel. Like taking a debt, paying it up, and taking yet another debt. Typically this is not a good position, as it is very susceptible to changes.
L – The loser’s depression. Everything was good, then there is an acceptance of failure and life continues at the lower point.
So, how do we stay winners? Let us consider various approaches.
Focus on what we can control
This is a sort of a no-brainer, yet people take it too literally. One of the reasons people buy so much toilet paper during the COVID-19 crisis is a sort of anal fixation. At least that part we can control.
We can consume healthy food with vitamins. It is probably a good idea to use the staycation to sleep. If there is any skill we wanted to acquire or any project we wanted to build, do it.
What about discipline? Should we be disciplined, or are we taking it too far?
Are common policies justified?
This is a bit strange. We get guidelines and we want to follow them, yet we do not always understand them properly. Maybe the guidelines are too harsh or not harsh enough? The guidelines tend to change. Should we literally follow them?
The best approach is understanding the goals and limitations of the decision-makers. Then we can decide for ourselves to what extent the decisions are reasonable. Initially, we probably do not have the information and should either trust the choices made by our own decision-makers or choose alternative paths of their competitors.
As the decision-makers need to defend their choices, they share more information than they would like. At the same time, third party criticism becomes available. We also have time to process our own thoughts. Then we can make better choices.
Gamble with your life
In chess everything is transparent, and we can plan many steps ahead. Real-life situations are often more similar to gambling. It is a good idea to start from the endgame: what are the chances and how much can we risk?
What are the chances of something bad happening? Is it reasonable to pay the insurance? Maybe we want to pay more? Will the insurance help if the worst happens? If the chances are below 1:10000 we may as well hope for the best. When the chances are above 1:100 probably it is best to take some protective measures.
The same idea goes for a lottery. If there is a huge win with low probability and low entrance fees, should we pay the fees? If the chance is 1:10 we will probably lose. Yet if the expected outcome is 1:100, should we take the chance?
Risk penalty
A mathematical way to handle it is also not clear. The simple approach says: use expectation. E.g. take the chances of each outcome and multiply them by possible outcomes. If the average outcome is above the cost, the gamble is worth-while. In real life, we should probably modify the formula with some sort of risk penalty based on the game we play.
If we build a portfolio with moderate risks, the common idea is to use something like the Markowitz model:
- RP = IRF + (RM – IRF)σP/σM
where,
- RP = expected return of portfolio
- RM = return on the market portfolio
- IRF = risk-free rate of interest
- σM = standard deviation of the market portfolio
However, if we risk a ruin the model is different, like Powers-Gerber-Shiu function
- ,
![m(x)=\mathbb{E}^x[e^{-\delta\tau}w(X_{\tau-},X_{\tau})\mathbb{I}(\tau<\infty)]](https://wikimedia.org/api/rest_v1/media/math/render/svg/e0487fe3b43cb212e8083bf16f7f70a7e22b733f)
where is the discounting force of interest and is a penalty function capturing the economic costs to the insurer at the time of ruin (assumed to depend on the surplus prior to ruin and the deficit at ruin ), and the expectation corresponds to the probability . Here the indicator emphasizes that the penalty is exercised only when ruin occurs.
This math is OK for a bank or insurance company, but almost useless for an individual who does not have the resources to make many games or the statistics.
Start from the endgame
As a human being rather than a mathematician, I typically start from the likely endgame and go back. Everything with a chance less than 1:10 should be even considered only if the costs are less than 4 monthly revenues. Very few likely scenarios will probably span 90% of possible outcomes.
Now for each outcome, suppose that it happens. What can I do now to be in a better position in such case and how much will it cost? Notice that some of the costs we pay to improve our positioning will not pay off. For example, if we short the market via ETF in case of a huge economical disaster, and there is a great government package, we avoided personal ruin yet we paid for it with some penalty.
It is impossible to win always, but we can optimize the most likely result for 90% of the cases. And then there are cases where we should look for a different game. For example, a huge earthquake in California will eventually happen. We might either live in a safer place or hope it will not happen in our lifetime. At least we can enjoy the good times…
Focus on here and now
Possibly there is too much uncertainty to see the endgame. In this case, we can at least improve our position. In chess, a good player can evaluate very accurately each position. We may not see immediate break-throughs, but we need to take action. So we make small steps that objectively improve our position and wait for the opportunities.
This can be used for organizations or personally. And I do not discuss pleasures. I am talking about taking courses, building projects, reading books, finishing the stuff we usually do not deal with. Building up motivation is also interesting, especially we can generate a moral “high ground”. When we find purpose we become stronger.
Consult our future self
When still in doubt, we can consult our future self. What actions or inaction will we regret 20 years from now? Maybe no matter what we do, our actions will not shape the future? What do our friends do in similar situations? How will our mentors react faced with the same challenges?
Quite often we need some distance from our current situation. The small details may be very important for us right now, but we understand that they will be handle anyway. The big issues may wait, yet they need handling. Our future self is wiser this way… Why not ask him?
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