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You Know What? I Know I've Got To Do Something About Known Knowns

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In a culture that rewards expertise no one owns up to ignorance. Politicians, professionals, even columnists, know it is better to be confidently wrong than honestly to admit to being in the dark.

But who, hand on heart, can say they are not confused and a bit scared by today's unfolding financial and economic crisis? I am sure the only really honest response to the current situation is "I don't know".

When Hank Paulson performed his reversal on TARP within days of unveiling his bail-out plan, I knew that far cleverer people than I were out of their depth. Listening to Alastair Darling justifying his second stab at rescuing the UK's banking system, I'm quite sure he doesn't know. Mervyn King's not sounding too confident either.

Does this worry me? Not unduly, because in reality the future is no more cloudy than it ever has been. Even when we thought we could see more clearly, we knew that Yogi Berra was right to say "predictions are difficult, especially about the future".

I'm reminded of another deceptively profound comment about uncertainty from former US secretary of defence, Donald Rumsfeld. In an unfairly derided remark in 2002, he said: "There are known knowns; things that we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns – the ones we don't know we don't know."

Every investor should clip this quotation and put it on their desk, because it contains an important truth. There are some things we should worry about because we know what they are and can do something about them; there are other things that we should worry about because, although we do not know what will happen, the possible outcomes are limited and we can prepare for them; finally, there are things that we cannot predict and should therefore stop worrying about.

This last category includes events such as the attacks on the twin towers or Hurricane Katrina. The only thing to remember about unknown unknowns is that they happen a great deal more frequently than statistical models predict.

The second category is particularly interesting today because there are now many known unknowns, situations we do not fully understand but which have a limited set of possible outcomes. For example, I don't know whether the various attempts to re-invigorate the world's economy will fail, leading to deflation, or succeed too well, giving us high inflation later on. In the first case, I will want to own government bonds, in the second, inflation-linked bonds, equities and a house will do the job. Because I don't know which it will be, it makes sense to own all four and to stop worrying.

Similarly, I don't know if the oil price will stay at $40 or bounce back to $140. But I do know how to stop fretting about it. I know how many miles I drive a year and I know what happened to petrol's price when oil was at its peak. It's a simple calculation, therefore, to work out how much I need to park in an oil exchange-traded fund to offset the higher cost of fuel if the price of crude takes off again. If it falls, I will spend a commensurately smaller amount on petrol. Either way, I've tamed a known unknown.

It's the first category of known knowns I should concentrate on. These are things I know that I know and over which I exert some control. Here are five:

• I know that if I don't insure my life and my house then there is a slim chance that my family will be out on the street.

• I know that if I don't save a sensible slice of my salary every month for the rest of my working life then my retirement isn't going to be much fun.

• I know that if I don't diversify my assets there is a small chance that I will strike lucky and a much bigger probability that I won't.

• I know that every year that I use my ISA allocation for myself and my wife I lock in an unrepeatable free gift that will compound in value for the rest of my life. I know that if I don't use it, I will lose it.

• Finally, I know that if I had invested at the end of any one of the 32 10-year periods since 1871 in which the US stock market recorded a negative annual total return, I would have made money in the next 10 years.

I know the period to the end of 2008 was the latest of these 10-year periods. Will history repeat itself?

I would be surprised if it didn't but, guess what, I don't know.

The wonderful world of guessonomics.

No one really knows how all of this will unfold, but currently the idiots in charge seem to be doing their best to make things far worse than they should be.

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  • 284 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?

      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%

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