People have trouble with risk. Sometimes needlessly. It is partly because of how they process information and what they expect to get from that processing.
In the West, most of our thinking follows the logic of Aristotle. While it is a powerful tool, if overdone, it leads to complications that cannot be resolved using its rules.
Aristotle says a thing is true or it is not true. A convenience in his system, but far from what we see in our lives. A log is not a chair, but if we are sitting by a campfire, a log has a certain “Chairness” not contemplated in his system.
Deductive reasoning is in the familiar A and B then C. The unique feature is that deductive reasoning guarantees the conclusion. The world holds few guarantees so there must be other forms of reasoning. Deductive logic does not work in most of the real world.
Inductive reasoning (Inference) is a close second to deductive. It goes the other way. From observation back to the premises. I have observed a large number of white swans and no swans of any other color. I can reasonably say that all swans are white, but I cannot guarantee the certainty of my conclusion. Absence of evidence is not evidence of absence. I could say with high confidence that if I see another swan in this place, it will be white, but I know nothing about other places.
The third form is one we use instinctively and the one about which we know the least. Abductive reasoning is a form of inductive reasoning, but it is more intuitive. There are fewer supporting observations. Sometimes just one. Be careful, it can lead to conclusion jumping. (Soon to be an Olympic sport)
In financial planning, you cannot use deductive reasoning alone. The world is too complicated. There are no certainties. We are forced to use induction or abduction to reach our conclusions and because neither provides certainty we feel unsettled.
If we define risk to be the white space between what we know and what we need to know and do to be certain, then risk is always present. The white space is filled with things that we could know but don’t, and those things that exist only in our future and of which we can know nothing.
We must infer where there is a lot of evidence and abduct where there is little. Neither method provides certainty and either can turn out very wrong.
The defense is the “3 R’s” – Record, Review and Revise. No one rational can create a financial plan that is guaranteed. The 3 R’s permit the course adjustments, usually minor, that you need to keep it on the evolving path presented by the future.
Record, review and revise is how you attach the meaning of the world to your particular meaning. It is a learning experience and a way to acquire more observations. Do not overlook it or treat it as a minor part.
The certainty is that it may be the only part of the plan that matters.
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Don Shaughnessy is a retired partner in an international public accounting firm and is now with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.