Risk vs UncertaintyCopy Anchor Link

Risk vs UncertaintyCopy Anchor Link

The corpus treats risk not as volatility — the academic convention — but as the probability and magnitude of losing money, and treats uncertainty as the broader unknowability of future outcomes that surrounds every investment. howard-marks is the principal theorist of both; warren-buffett states the same distinction in plainer terms.

Marks's 2006 memo Risk is his definitive statement. He rejects the slogan that "Riskier investments provide higher returns" as backward: higher expected returns are what riskier investments must offer to attract capital, but they are only sometimes delivered. Returns alone tell half the story — "We have to know how much risk they took to get those returns" before judging skill, which is the origin of risk-adjusted returns. The capital market line sloping up to the right encodes a positive expected relationship between risk and return, not a guaranteed one.

The distinction between risk and uncertainty is drawn explicitly in The Happy Medium: higher expected returns must be accompanied by "greater uncertainty (a broader dispersion of possible outcomes) or higher actual risk of losing money." Uncertainty is the spread of what could happen; risk is the chance and size of a bad outcome. Marks restates this throughout his work: as expected return increases, "so does the accompanying risk (the uncertainty surrounding the outcome and the likelihood of a bad one)".

The 2020 memo Uncertainty is the fullest treatment of unknowability. Marks argues economics is the dismal science because, unlike physics, it has no if a, then b rules — "only patterns that tend to repeat ... they're still only tendencies." He adopts a hierarchy of epistemic confidence: facts, logical inferences from past experience, and guesses — and holds that about the economic future "there certainly are no facts." The practical conclusion, repeated in You Can't Predict, You Can Prepare (November 2001), is that the investor cannot forecast but can position for a range of outcomes.

Buffett arrives at the same place through a different vocabulary. In the partnership years he defined conservatism as minimizing "risk of permanent capital loss (not short-term quotational loss)", explicitly severing risk from price fluctuation. And in the 1964 letter he argues that "Neither a conventional nor an unconventional approach, per se, is conservative" — true conservatism follows from "intelligent hypotheses, correct facts and sound reasoning", judged against performance in declining markets.

The implication for practice is that because the future is uncertain, the investor's defenses must be structural rather than predictive: a wide margin-of-safety, a willingness to be wrong, and an awareness of where the cycle stands. Risk and uncertainty are thus the background against which every other concept in this wiki operates. See cycles.

SourcesCopy Anchor Link

• howard-marks/Memos-Markdown/2006-01-19 - Risk.md
• howard-marks/Memos-Markdown/2004-07-21 - The Happy Medium.md
• howard-marks/Memos-Markdown/Ruminating on Asset Allocation.md
• howard-marks/Memos-Markdown/Uncertainty.md
• buffett-partnership/Letters-Markdown/1962_Letter(3)_19630118.md
• buffett-partnership/Letters-Markdown/1964_Letter(2)_19650118.md