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One of the most difficult realities investors face is that the future is never certain. Every investment decision involves probabilities, not guarantees. Yet our brains desperately want certainty. We want to know what’s going to happen next, and when we don’t, we often substitute confidence for evidence.
This tendency lies at the heart of many poor investment decisions.
I explore this idea in more depth in Investment Illusions, but it begins with a simple truth: our brains were never designed to think naturally in terms of probabilities.
A Few Probability Questions
See how you do with these.
- Which is more likely: winning the lottery with your favorite six numbers or with the numbers 1, 2, 3, 4, 5, 6?
- There are 50 people in a room. What are the chances that two people share the same birthday?
- If you flip a coin 20 times, what is the probability of getting four heads or four tails in a row?
- A mutual fund has a 93% chance of producing a positive return in any given year. What is the probability it will be positive on any single day?
The answers surprise most people.
The lottery combinations are equally likely.
With 50 people, there’s about a 97% chance two share the same birthday.
There’s roughly a 77% chance you’ll flip a run of four heads or tails.
And despite a 93% probability of a positive year, the chance of the investment being positive on any given day is only about 54%.
That last example is particularly important.
Many investors know markets generally rise over long periods. Yet because they watch daily fluctuations, it often feels like investing is far more dangerous than it actually is. Time changes probabilities.
When Probability Feels Like Certainty
Our brains also struggle to distinguish between likely and certain.
If the weather forecast says there’s only a 10% chance of rain, many people hear, “It won’t rain.”
If it does rain, they conclude the forecast was wrong.
But it wasn’t.
A 10% chance means that, on average, it should rain about one out of every ten similar days.
The same thing happens in investing.
A recession may be unlikely, but that doesn’t mean impossible. A market rally may be probable, but that doesn’t make it guaranteed.
Probability is not certainty.
Why Surprises Aren’t Always Surprising
The 2016 U.S. presidential election provides a good example.
Many people claimed the polls “got it wrong” because Donald Trump won.
But most major forecasts never assigned him a zero percent chance. On election morning, FiveThirtyEight gave Hillary Clinton roughly a 71% chance of winning, which also meant there was nearly a 30% chance she would lose.
That’s not impossible. That’s probability.
The surprise wasn’t that the lower-probability outcome occurred. The surprise was that many people interpreted “more likely” as “certain.”
Investors make this same mistake every day.
Black Swans Feel More Common Than They Are
Events like the 2008 financial crisis or the COVID-19 pandemic leave powerful emotional memories.
Because they’re vivid, our brains naturally overestimate how likely they are to happen again.
This is one reason investors often remain overly cautious long after a crisis has ended. They’re preparing for the last disaster instead of the next opportunity.
Black swan events do occur. They always have. They always will.
But allowing fear of extremely unlikely events to dictate every investment decision often creates a much larger risk: failing to stay invested long enough to reach your financial goals.
The Better Approach
You don’t need to become an expert in probability theory to become a better investor.
You need a disciplined process.
Markets are uncertain. Forecasts will sometimes be wrong. Unexpected events will happen.
None of that changes the importance of having a diversified portfolio, a long-term plan, and the discipline to follow it.
Successful investing isn’t about correctly predicting every probabilistic outcome. It’s about making consistently good decisions despite uncertainty.
Related: The Best Advisors Don't Share the News—They Shape the Narrative