Investment Decisions in an Uncertain Environment
Each year, investors around the world make countless decisions on how to effectively invest billions of euros to achieve the greatest possible returns. Being one of these investors yourself, you already know that each investment decision is engulfed in deep uncertainty. No investment is risk-free, and a wide range of factors play a role in whether the projected returns will be realised or not.
The past year taught us that there are always risks, circumstances and situations that can be neither foreseen nor quantified when making investment decisions. This does not mean that we should ignore these, however. The best decisions are ones which acknowledge uncertainties and work against them. In this blog post, we would like to discuss the role uncertainty plays in decision making and how best to factor it in to make effective investment decisions.
The Vaccine Example
It would be difficult to put forward a better example to illustrate uncertainty right now than the vaccination programmes worldwide. There are numerous vaccines already available - the Pfizer-BioNTech, Moderna and Oxford/AstraZeneca being among the most widely known. The race to develop each of these vaccines started very early on in the pandemic. Neither the pharmaceutical companies nor the governments knew at the time whether a vaccine will be required to tame the pandemic and whether it will even be possible to develop one.
Irrespective of this uncertainty, the pharmaceutical companies took the risk to invest their funds and energy in research and development of a suitable vaccine. While a successfully developed vaccine could mean revenues for the company that would cover the cost of research and development, a failed attempt would mean the companies would have to bear the losses.
Similarly, governments across the world were forced to decide early on which vaccines they would put their trust in and start ordering (and paying) without knowing whether any of the vaccines would prove effective and whether they would pass the required safety tests.
In both cases, the decisionmakers were fully aware of the risks and the possible costs of the uncertainties involved. Yet, it was not possible to calculate with any significant certainty the probabilities of the risks materialising.
Calculations and Projections
It is often easier to calculate the cost of any given uncertainty than to project the probability of it occurring. In the vaccine example, the pharmaceutical companies could easily add up the funds that they were pouring into research and development of the vaccines. At any given point in time, this was the amount of money they could lose in case the vaccine development was unsuccessful or in case their vaccines were not required. However, calculating the probability of the vaccine failing or there being no demand for it was practically impossible, especially in the initial stages.
As the pandemic raged on, the uncertainty of whether a vaccine would be required diminished - very soon, it became evident that a return to normality was impossible without an effective vaccine. The uncertainty of whether any given vaccine could be successful also decreased, albeit at a much slower pace. To put it into perspective - there were over 130 vaccines in the works in early 2020, and at the time of writing this blog post, only four have been approved for full use, while six have been authorised for emergency use in only several countries.
Those pharmaceutical companies, which are still developing their vaccines, continue to face uncertainties. They may never achieve the result of an effective vaccine. And, even if they do develop an effective vaccinee, this may be too late if competitors have already saturated the market. Without trying to create the vaccine, though, they do not have a chance of earning any profits from it. As a business, they are motivated by the prospective profits to keep investing in the development process, even when faced with the uncertainty of failing.
The Lessons We Can Learn
Only those who do nothing never fail, but they also never achieve anything. Imagine the pharmaceutical companies at the beginning of the pandemic weighing the chances of success and concluding that there are too many uncertainties for them to start the race for a vaccine. Where would the world be one year on? Most probably still fighting the pandemic, but without even the slightest hope for a vaccine that could stop it.
It is very similar for investors. Decisionmakers often face unnecessary pressure that a given investment decision is absolutely certain and risk-free. Although we may all feel more comfortable when facing risks that can be easily quantified, presuming that all risks have been calculated when making an investment decision is the most significant risk of all. It may lead us to oversee the real threats to our decisions and influence us to make poor investment decisions that fail when the future surprises us. Or, even worse, it may wrongly affect us not to invest at all just because there are uncertainties.
It is always safer to acknowledge the uncertainty rather than present a decision as certain and failproof. By understanding the threats that uncertainty may pose to our choices, we will be better equipped to make decisions that are robust to an unpredictable future. It will also allow us to make investment decisions without the fear of failing.
Investments can and should be made even in an uncertain environment. Not only because no investment environment will ever be entirely predictable, but also because the higher the uncertainty, the higher the possible returns. Taking advantage of an uncertain environment without fear is what sets the true investors apart from the amateurs.