Uncertainty and Risk — How to deal with them

Recently, I read the book called ‘The End of Alchemy: Money, Banking, and the Future of the Global Economy’ by Mervyn King who makes some great points about how our financial system is based on Alchemy (Banks creating money out of thin air) and deeply flawed in the way it’s incentivising individuals working in it. Great book, a bit dry here and there.That put aside, one point that really stuck with me is how the behaviour of households is explained by the notion of uncertainty. Surely, having sat through economy classes in uni, I knew that in economic theory individuals assess future events by their probability and their potential impact on their well-being, or the so-called “utility.” Therefore, they always do what’s rationally best: to optimize that “utility.”To give an example, let’s say that despite great news about vaccine efficiencies, you’re very certain that we won’t get around further time of social distancing and staying at home. Therefore, you believe that shares of tech companies will continue rising in value, and might use the dip they’ve experienced to buy even more. *Do not take this as investment advice btw.Unfortunately, it is not that easy to assess each possible outcome as some things about the future, we simply do not know. Could our ancestors possibly have known, that one day we would produce energy from solar panels or trash the planet with plastic? Certainly not. What they had an idea about was the risk of drowning when swimming through a river and the dangers of wild animals.While some confuse risk and uncertainty, certain factors are differentiating them and understanding both can help in decision making. So let’s start with risk.RiskAccording to the Cambridge dictionary risk is “the possibility of something bad happening.” When it comes to trading and investing, risk is…