How to manage the biggest risk of all: Uncertainty 

These are uncertain times, but we have never lived with less risk. That may sound crazy coming out of a pandemic that disrupted our lives in uncountable ways — and now we may be on the brink of World War III. But there is a big difference between risk and uncertainty and each requires different coping strategies. Risk can be managed with insurance or hedging; Uncertainty demands flexibility.

That is important to know when making big life decisions like buying a house, changing jobs, having a baby, retiring or even adjusting your portfolio.

Risk includes things we can measure and see coming, uncertainty arises from the things that take us by surprise. Society has become very adept at measuring and managing risk with the help of data and technology. We see this in the stock market, in the housing market and even in our culture where data can increase the odds we will enjoy a movie on Netflix or a song on Spotify. When it comes to things we can measure, much less is left to chance. And if we cannot eliminate risk we can insure against it: using stock options as insurance against a falling share price, for instance.

Since the 1970s we have had more ways than ever to manage or eliminate risk in markets, in the economy and in many aspects of our daily lives. The payoff was rising markets, low inflation (until recently) and stable wages and jobs. So we are gobsmacked when we are hit by something we did not expect — like pandemics and wars that send the world spinning.

For most of human history, people lived with uncertainty and risks they could not manage. Violent wars and deadly disease outbreaks were a fact of life. This changed in the 20th century when the government took on more of our risk; Welfare programs eased hardship, countries cooperated through international organisations and more trade and technology gave us more tools to insure against risk. In the 1970s the word risk became associated with something you could manage or avoid.

But the last two years may mark a new era. We can still manage risk and have better tools to do so, but in the new world order, it is about managing uncertainty — a much more difficult proposition. You cannot plan for the unforeseeable.

It is still possible to manage the risks that arise from uncertain times, but it requires a different strategy — it takes resiliency. Governments and central banks had the flexibility that made the pandemic less bad than it might have been. They had the fiscal space and credibility to throw tons of money at the pandemic with enhanced unemployment benefits, stimulus checks and massive purchases of debt. The mRNA technology is remarkably flexible and scientists used it to develop a vaccine in record time.

Now the Russian invasion of Ukraine poses a new source of uncertainty: Cold War economics, nuclear weapons, food shortages, cyber attacks, China's reaction to everything — all are impossible to predict. We have risk-management tools in fiscal policy and in re-engineering global markets such as energy and that will help make the crisis less risky. But as the last two years have shown, risk-control cannot shut out uncertainty. And individuals must figure out how to manage their own lives.

Our first instinct when faced with more uncertainty is to avoid making decisions, bulk up on cash, do not relocate, wait on retirement and avoid new debt. But the heightened uncertainty may last a long time and you cannot just keep your life on hold. Cash is normally attractive when times are uncertain, but with inflation today it is not a safe strategy either. We still need to invest in risky assets and if you put off a house, baby, or job change you may be waiting a long time.

So to manage uncertainty, the best thing you can do is promote resilience by not taking excessive risk and promoting flexibility in your life. Invest in stocks, but avoid assets that are illiquid or excessively volatile. If you are thinking about retirement, you needn't have to wait, you just need to keep your options open for a possible return to part-time work.

The same principle applies if you are considering buying a house or changing jobs. Rather than going for that big fixer-upper in an up-in-coming neighbourhood, buy a smaller house in a better neighbourhood that you know you can easily resell if the housing market sours. It could be planning on a part-time job if you go back to school or a side hustle if you take a less stable job. Or, when it comes to cyber risk, hold on to paper copies of your bank statements and make sure your computer is backed up to the cloud or an external hard drive.

We have been fortunate this past half-century to live in a world with remarkably little risk most of the time. But it also made us more vulnerable in other ways. We discount the unexpected because we rarely experience the costs of bad shocks. Companies hold fewer inventories when they do not worry about global supply chains breaking down; we take on more debt if we do not expect to lose our jobs or we might book a non-refundable trip when we cannot imagine a pandemic disrupting travel plans.

The last two years have reminded us that no matter how much we minimise risk, we cannot plan for everything. We must build more options into our lives so that we feel less helpless when something big does go wrong.

Allison Schrager. Illustration: TBS

Allison Schrager is a Bloomberg Opinion columnist. She is a senior fellow at the Manhattan Institute and author of "An Economist Walks Into a Brothel: And Other Unexpected Places to Understand Risk."

Disclaimer: This article first appeared on Bloomberg and is published by special syndication arrangement.