Investments are risky. The future is uncertain. While both relates to the same underlying concept of randomness, how many of us truly understands the difference?
Risk involves an unknown outcome that can be calculated or defined. For example, playing poker or investing in a stock can be risk, but people always know their odds and possible losses. Uncertainty, in contrast, implies an unknown outcome that cannot be calculated or identified. For example, no one has the perfect foresight to predict the duration of a market correction or an economic recession.
— Ronald Chan, The Value Investors
How do we avoid them?
Everyone dislikes randomness. How do we avoid them it they are random?
Risk is an element present in every investment. It is unavoidable if we wish to be in this field. However, what we can do is picking the bets where we deem that the risk is minimal. Essentially this is what we know as doing our due diligence, before investing in any company, eliminating the companies where we deem the risk too high at current valuations.
Risk is measurable uncertainty. Uncertainty is unmeasurable risk.
Uncertainty are like how Nassim Taleb would put it, Black Swans. They are rare and unpredictable events. For example, POSCO. I have heard countless of arguments of how aluminium being a lighter material would come to overtake steel in terms of production of airplanes, cars etc. I have even heard statements such as perhaps one day no one would require steel anymore. While these are all valid statements, can we measure the probability of such an event?
Often we hear statements such as we diversify our portfolios to reduce our risk. However, diversification is not because our investments are deemed risky but acknowledging the fact that the world is uncertain.