Risk vs. uncertainty: you are playing the wrong game.

Imagine that you are camping near a lake for a few weeks, but you know the lake periodically floods.

Where are you going to place your camp?

?

Are you going to place it away from the water, so you know your chances of getting wiped out are low? Or are you comfortable taking risks to enjoy the full lake experience but accept that you may end up underwater?

?

This is the question many ask themselves when designing their investment portfolio or financial plan.

?

But what if there was a way to build a boat instead? A boat that fluctuates with whatever water levels decide to show up that week.

?

We need to make sure we are playing the right game. Which means we are using the right setup tools.

?

This article is part 1 of 2. Today we will answer:

?

1)??? Do we understand the game we are playing?

2)??? Do we understand the problem we are solving?

3)??? Are we using the right tools?

?

The goal of this exercise is to make sure you are creating the most resilient and durable financial strategy possible.

?

Risk vs. uncertainty – Do we understand the game?

?

Do we understand the game we are playing, and did we bring the right tools?

?

Let’s first start off by examining games of risk.

?

The best example is a casino.

?

A casino knows the game. It is like rolling a pair of dice. We know the distribution of outcomes in advance. We know the range of outcomes. We know the probabilities.

?

This is actually a very easy game to play for a casino and is highly predictable. A simple system.

?

Let’s look at a slightly more complex system but still playing the game of risk.

?

Auto Insurance.

?

An auto insurance company does not know the exact game, but they can accurately estimate the game.

?

They have a lot of data, claims, and time that help them answer all the outcome questions addressed above for the casino.

?

The auto insurance game is a mostly predictable game.

?

But the game you are playing when building your financial strategy is not a game of risk. It is not a simple system. It is a game of uncertainty which is a very complex system.

?

We live in an unpredictable world.

We do not know the distribution of outcome. The range of possible outcomes is large and difficult to estimate. The odds of each possible outcome are known or not useful.

?

Our experience is unique, not generalized.

?

Do we understand the problem we are solving?

?

Now that we understand we are trying to solve for uncertainty you can begin to build a more durable and resilient financial strategy.

?

A key concept that I encourage you to think through is how you are exposed to multi-dimensional unpredictable risks. Not single-dimensional.

?

What matters is can you survive both an acute economic recession and a high inflationary environment. Can your dependents survive if you pass away and prolonged adversity occurs? Can you weather a storm where you lose your job and get caught up in a personal liability claim?

?

There are endless examples. The question is-can you weather the storm for multiple unpredictable events?

?

Are we using the right tools?

?

Now that we understand the game and understand the problem we are solving – what tools do we use?

?

Traditional methods are often using the wrong tools. They are focused on the wrong problems.

?

They are focused on the wrong risks, the inputs are inadequate, and they ignore your full financial structure.

?

Simulations are not risk management. Simulations provide expectations, not solutions.

?

Remember we need to build a boat.

?

So, let’s address uncertainty with solutions.

?

Below is an image of how you might go about personalizing a strategy for uncertainty.

?

These are all events that we need to hedge for. All these types of events affect your specific financial structure differently.

?

The next article will dive more into how you can manage some of these risks by hedging, insuring, diversifying, and having a reserve.

?

Closing Thoughts

?

If you leave with anything, I hope you realize that your life is not a casino, and it is not appropriate to “roll the dice.”

?

You should choose to stay on a boat, which floats regardless of the water level.

?

When building your solution, ensure your liquid portfolio, reserves, properties, private assets, insurance, and wealth products work together so that your financial success is as robust to the unexpected as a boat is to changes in water level.

?

While we cannot eliminate bad luck and surprises, we can change how they affect us when we address uncertainty head-on.

?

Subscribe here?if you want to receive my client communication and newsletters.

?Drew Lunt

Scratch Capital

[email protected]

208-901-8018

Disclosures and Sources

Advisory Services are offered through Scratch Capital LLC, an Investment Advisor in the State of Idaho. All content is for information purposes only. It is not intended to provide any tax or legal advice or provide the basis for any financial decisions. Nor is it intended to be a projection of current or future performance or indication or future results. Purchases are subject to suitability. This requires a review of an investor’s objective, risk tolerance, and time horizons. Investing always involves risk and possible loss of capital.