I’d like to spend sometime on something we know nothing about. Uncertainty.
Admittedly, that’s a feeble attempt at humor, but you’re not alone if you don’t get the joke. One thing that confuses many is the distinction between Risk and Uncertainty.
In everyday language, these words are often used interchangeably. But they have two different – diametrically opposed – meanings in finance. Both mean situations where something goes wrong. A loan doesn’t get repaid. An investor’s capital is lost.
Such a bad event is Uncertain if the odds of it happening can’t be measured. With uncertainty, you are completely in the dark.
Risk, on the other hand, means a negative event that can be measured or calculated in some way. In lending or investing, risk is often measured in terms of probability, or odds.
Risk is still something to be avoided. But it’s immeasurably better to be dealing with risk rather than uncertainty. Whether its high or low, risk is something you can plan for. Prepare for. Put structures in place around it.
This is where data can make a difference, of course. Having good quality data (or knowing how to look at data) can turn a situation from uncertainty to risk. It can make the measurement of risk more precise. Potentially, it can even show there is far less risk than was first assumed.
All this doesn’t make dealing with risk any easier. But with uncertainty, there’s no deal at all.