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Investing in Uncertain Times

The lesson of 2020 is that we live in an era characterized by uncertainty, and investors need to adjust, says James K. Glassman, Kiplinger’s Personal Finance magazine.

Frank H. Knight, who received his PhD in 1916 and taught for 50 years, was an enormously influential economist and the mentor of three Nobel Prize winners. He devised a theory that held, “Uncertainty must be taken in a sense radically different from risk.”

Uncertainty, in the Knightian sense, is an unmeasurable risk. It’s something that has never happened before – for example, the attacks on the World Trade Center in 2001, the financial meltdown of 2008, or the coronavirus pandemic.

The rapidity of these events is not just bad luck. Rather, the world has grown more uncertain. One reason is that we are more connected. A disease in Wuhan, for example, can travel to New York in a few hours.

So how should we deal with uncertainty as investors? Not by running from it. Markets, by their very nature, reward investors for taking risks. In fact, Knight’s contribution to economics was to show that entrepreneurs reaped profits because they were willing to challenge a world of uncertainty. Uncertainty is a major reason that stock returns are so high today. We’re getting paid extra because the world is extra-uncertain.

In their new book, Radical Uncertainty, British authors John Kay and Mervyn King write that “good strategies for a radically uncertain world avoid the pretense of knowledge.” Their first lesson for investors: Trust your gut. Buy companies that you believe have terrific ideas even if you are not sure how they will work out in the future. Good examples are Uber Technologies (UBER), which, despite a COVID setback, is creating a transportation revolution; Walmart (WMT), which is figuring out how to blend traditional and online retailing; and fintech firms such as Netherlands-based Adyen (ADYYF), a booming global payments platform.

The second lesson is to be a long-term stock investor. The recovery of the stock market from its COVID crash in February and March was unusually dramatic, but markets do always come back.

The third lesson is to collect the cash while you can – that is, buy stocks that pay good dividends. They abound these days in diverse sectors, and it is not hard to find companies that yield twice what 30-year Treasury bonds pay. Some examples: Principal Financial Group (PFG), the insurer and asset manager, International Business Machines (IBM), utility Southern Co. (SO), and pharmaceutical firm Merck (MRK).

Also consider iShares Select Dividend Index (DVY), an exchange-traded fund whose portfolio consists of stocks that have increased their payouts in each of the past five years; Vanguard High Dividend Yield (VYM); or T. Rowe Price Dividend Growth (PRDGX).

Knight realized that to succeed as an entrepreneur, you have to take a chance on the unknown. The same is true for investors.

Editor’s Note: James K. Glassman is a contributing columnist at Kiplinger’s Personal Finance magazine.

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