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Risk is everywhere in investing — that much is obvious. What’s less obvious is that not all risk is created equal. Nearly a century ago, economist Frank Knight made a crucial distinction that’s still reshaping how smart investors think today: the difference between risk and uncertainty.
In his view, risk is something we can measure. It’s the kind of probability we can calculate, like the odds of a company missing earnings or a bond defaulting. But uncertainty? That’s something entirely different. Knightian Uncertainty is about the unknown unknowns — the future events we can’t predict, quantify, or even imagine.
Understanding this difference isn’t just an academic exercise. It has major implications for how we invest, especially in times of volatility, disruption, or rapid change. Here’s why embracing, not ignoring Knightian Uncertainty could be a valuable contemplation when looking at investment portfolios.
So How Do You Invest in the Face of Uncertainty?
Accept that models have limits - Relying solely on historical data or quantitative risk models can give a false sense of control. Markets don’t repeat, they rhyme, and sometimes they surprise.
Prioritize resilience over optimization - Portfolios built for a narrow range of scenarios can break when faced with true uncertainty. Instead of chasing the highest possible return, consider how your portfolio will respond across a wide range of unknown outcomes. This might mean holding more cash, owning uncorrelated assets, or reducing leverage.
Diversify by worldview, not just asset class - Traditional diversification (stocks, bonds, etc.) is necessary but not sufficient. Knightian Uncertainty calls for conceptual diversification, exposure to investments that respond to different visions of the future (e.g., green energy vs. fossil fuels, developed markets vs. emerging ones, centralized vs. decentralized systems).
Favour simplicity - In uncertain conditions, complex strategies often fail because they rely on fragile assumptions. A broadly diversified, low-cost, long-term strategy often proves more robust when the unpredictable happens.
Stay humble and flexible - The best investors don’t pretend to know the future. Instead, they build systems that adapt to it. Rebalancing regularly, reassessing goals, and being willing to shift your strategy as new information emerges are all part of managing uncertainty.
Why This Matters Now More Than Ever
Today’s world is thick with Knightian Uncertainty: AI is reshaping work, climate events are escalating, global politics are shifting, and financial norms are being challenged by everything from crypto to central bank digital currencies.
In such an environment, investors who seek comfort in precision are often caught off guard. Those who accept uncertainty, and plan for it, are better positioned not only to withstand shocks, but also to take advantage of them.
The Bottom Line: Embrace the Unknowable
You can’t model everything. But you can prepare for anything.
Knightian Uncertainty reminds us that investing isn’t just about crunching numbers, it’s about acknowledging the limits of what we know and building portfolios with the potential to be strong enough to handle what we don’t. So instead of fearing the unpredictable, start factoring it in. The future may be uncertain, but your strategy doesn’t have to be.
The information contained herein has been provided by TD Asset Management Inc. and is for information purposes only. The information has been drawn from sources believed to be reliable. The information does not provide financial, legal, tax or investment advice. Particular investment, tax, or trading strategies should be evaluated relative to each individual’s objectives and risk tolerance.
Certain statements in this document may contain forward-looking statements (“FLS”) that are predictive in nature and may include words such as “expects”, “anticipates”, “intends”, “believes”, “estimates” and similar forward-looking expressions or negative versions thereof. FLS are based on current expectations and projections about future general economic, political and relevant market factors, such as interest and foreign exchange rates, equity and capital markets, the general business environment, assuming no changes to tax or other laws or government regulation or catastrophic events. Expectations and projections about future events are inherently subject to risks and uncertainties, which may be unforeseeable. Such expectations and projections may be incorrect in the future. FLS are not guarantees of future performance. Actual events could differ materially from those expressed or implied in any FLS. A number of important factors including those factors set out above can contribute to these digressions. You should avoid placing any reliance on FLS.
TD Asset Management Inc. is a wholly-owned subsidiary of The Toronto-Dominion Bank.
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