David Ricardo made a fortune when he bought British government bonds on the eve of the Battle of Waterloo; Warren Buffett sold insurance to the California earthquake authority. These investors have earned extraordinary returns by investing in what could be regarded as the unknown and the unknowable. The step they took was based on principles. These principles defy three major challenges in the world of investment which are risk, uncertainty and ignorance. These challenges are the simple reasons investors don’t know when and how to act when opportunity comes.
Most investors tend to follow traditional finance theories which do not apply in the world of the unknown and the unknowable. I use the word “unknown” to describe investments that could have a risky outcome while “unknowable” speaks of events that happen as a thunderclap, giving us little or no time to anticipate or prepare. However, once they happen, they become demystified. Nevertheless, the fear of the unknowable deters many from taking steps to invest.
Are we supposed to be afraid of the unknown and the unknowable? Warren Buffett once remarked: “It is essential to remember that virtually all surprises are unpleasant.” Whether positive or negative we should learn to see beyond such events. That will help us to know whether the end of the event will be celebrated or not. Most investors are masters of known situations, and even in such situations they still need to balance the expected gains and losses. In the light of this, investors who expect a geometric return on their investment should follow the steps of Buffet and others to become masters at investing in the unknown and the unknowable.
Here are some of the basic principles for investors who want to invest in the unknowable:
1. Strategic Thinking
Everybody talks about strategy, but you will be so surprised that the strategy most people talk about is only for known situations. Strategic thinking for unknown situations involves making key deductions from known facts. It also involves assessing factors that might deter others from investing so that you can take advantage of the opportunities created by those factors. This is not an easy task to do, because you must gather information based on trends such that you are able to explain the unknowable and understand why investors stay off such investments.
2. Understanding the Concept of Decision Analysis
Decision making is at the core of any successful venture. And one factor that aids decision making is knowledge. As an investor, you must not be overconfident. Rather, you need to get the required knowledge and analyse the information available to you. What overconfidence does is to that makes you over look what you would ordinarily have spotted.
Furthermore, to make the right decisions when investing in the unknown and the unknowable, you must know yourself. One way to do that is to review the failures and successes of past decisions. However, since most people do not have a long track record, they naturally turn to hypothetical situations from the past, and this is largely responsible for their mistakes. It doesn’t stop there; the two critical components of decision problems are payoffs and probabilities. Effective decision requires that both be carefully calibrated.
3. Seeing beyond the Obvious
Successful investors who have ventured into the unknown and unknowable see beyond what is presented on a situation. They look out for the underlying features of such investment. They pay attention to factors that may not be immediately obvious but which go a long way to determine if such investments are desirable or not. They approach this with all sense of responsibility.
4. Unusual Sense of Judgment:
Unusual sense of judgment is not developed in a day. It is the result of practising good sense of judgment over time before taking decisions. While practising you might not always come out successful, but you will learn from your mistakes and get better as you progress in making more decisions. For example, Warren Buffet is simply a genius at everyday tasks, such as judging management capability or forecasting company progress. He didn’t get there overnight, but through continuous practice.
When some companies are afraid of the unknown and the unknowable, they simply invite Warren to become a member of the board so that he can use his refined sense of judgment to determine if the investment they are about to make is worthwhile. You too can develop such capability if you will start now.
Fear is one of the unknown is one reason we hold back from investing. But if we follow the above principles we will master the art of investing in the unknown and unknowable. Nothing will be able to hold us back from achieving what we have set out to do.