The Only Guide You'll Ever Need for the Right Financial Plan: Managing Your Wealth, Risk, and Investments

Chapter 1. The Uncertainty of Investing

When there's uncertainty, they always think there's another shoe to fall. There is no other shoe to fall.

——Kenneth Lay, former CEO of Enron

Investing deals with both risk and uncertainty. In 1921, University of Chicago professor Frank Knight wrote (he is not the publisher) the classic book Risk, Uncertainty, and Profit. An article from the Library of Economics and Liberty described Knight's definitions of risk and uncertainty as follows: "Risk is present when future events occur with measurable probability. Uncertainty is present when the likelihood of future events is indefinite or incalculable."

In some cases, we know the odds of an event occurring with certainty. The classic example is that we can calculate the odds of rolling any particular number with a pair of dice. Because of demographic data, we can make a good estimate of the odds that a 65-year-old couple will have at least one spouse live beyond age ninety. We cannot know the odds precisely because there may be future advances in medical science extending life expectancy. Conversely, new diseases may arise shortening it. Other examples of uncertainty: the odds of an oil embargo (1973); the odds of an event such as the attacks of September 11, 2001; or the odds of an accounting scandal the size of Enron. That concept is uncertainty.

It is critical to understand the important difference between these two concepts: risk and uncertainty. Consider the following example.

An insurance company ...