We humans love certainty and hate uncertainty. For example, in my family, despite all the options, we continue to shop for groceries on Big Basket because we are certain of what we get and we have learnt to live without what we don’t get there. What is “certain” at Big basket? An assurance of quality, timeliness and good customer service.

Uncertainty is costly. It causes anxiety in the mind and consumes more mental resources. We are designed by nature to conserve our calories. it is for a reason why marketers selling “certainty” related products and services use phrases like peace of mind, rest easy, be at ease etc. So avoiding uncertainty and seeking certainty is in our natural wiring and therefore without much thought we tend to veer towards certainty. For example think of all the daily choices we make with certainty in mind:

• Preference for a job that pays steadily over being a business owner where there is unsteady income
• Preference for known brands and experiences (like my Big Basket experience) over the unknown
• Preference for an airline that is on time and less likely to cancel, like say Indigo, and therefore willing to pay a higher price for it

But can we quantify this love for certainty? According to Aesop – a bird in hand is worth two in the bush. According to Danny Kahneman, a large majority of us would choose a certain $800 over an uncertain but high probability $1000!

…consider the choice between a prospect that offers an 85% chance to win $1,000 (with a 15% chance to win nothing) and the alternative of receiving $800 for sure. A large majority of people prefer the sure thing over the gamble, although the gamble has higher (mathematical) expectation. The expectation of a monetary gamble is a weighted average, where each possible outcome is weighted by its probability of occurrence. The expectation of the gamble in this example is .85 × $1,000 + .15 × $0 = $850, which exceeds the expectation of $800 associated with the sure thing. The preference for the sure gain is an instance of risk aversion.

-Kahneman, Daniel. Thinking, Fast and Slow

We humans think we are smart and rational but in reality we are totally messed up. We say Yes when we want to say No and say No when we want to say Yes. We make messy, irrational decisions all the time. I want to write a book on how we make bad decisions all the time…but there is already a wonderful book “Thinking Fast and Slow” by Daniel Kahneman.

But let’s get back from an uncertain book in future to a certain blog in the present.

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Our love for certainty props up in money matters too. If there is something we love more than certainty, it is certainty with steady income. That is why we love financial instruments that like Fixed Deposits and Bonds or say Commercial Real Estate. But as Kahneman says, this love tends to be costly.

Ex 1: Bonds which promise a returns are preferred over equity because the former is assured whereas the latter is not. And all bonds are not equal. Bonds that offer the highest safety (aka certainty) offer the lowest returns. So, more the certainty, the more you are foregoing in returns (Bonds over Equity and AAA rated bonds over say AA bonds and so on).

Ex 2: REITs and INVITs which offer a steady source of income (at say 7 to 8%) are preferred over Index funds which are more unsteady but have delivered 12 to 14% over the long run.

Ex 3: I have a friend in the wealth management business. He invests in stocks for his clients and when the stocks go up a lot, he sells them. This way if the stock were to fall, his client would be protected. But if the stocks were to continue to rise, he would forego the upside. So in short, to limit the downside, he tends to limit the upside too. His behavior is driven by his clients’ love for certainty in returns this too is not free, if you factor in foregone returns, to the clients.

Ex 4: For people that live in a growing, thriving country like India, inflation is a give. Sometimes it is more and sometimes it is less and it overs around 5 to 6%. In other words, while your AAA bond may give you about 9% returns, you lose about 6% to inflation and you are left with a pre-tax real return of just 3%. That maybe good enough for some, but not for me.

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Certainty can also be good.

Ex 1: Bajaj Finance, one of India’s best businesses, borrows money from multiple sources and lends it many, lenders. So on a daily basis, Bajaj Finance borrows from it’s lenders and then lends that money onwards. And likewise, on a daily basis, borrowers repay money to Bajaj Finance and it would then repay it’s lenders. In 2013, because of Taper Tantrum, the credit markets froze and Bajaj was unable to borrow and thus was unable to lend. So they made a vital decision that at any given point of time they would always have surplus cash. That money would say sit in a fixed deposit and it would cost them; but that was okay because it was insurance for a rainy day.

Ex 2: Businesses want their critical IT applications to be up near 100% of the time. And for this they are willing to invest in additional resources which would be kept on standby. Should there be an outage in one datacenter, the backup data center takes over instantly. So the cost of high certainty (high availability) is the idling resources. Likewise a backup power generator ensures continuity of work even during a power failure.

Ex 3: We all have a spare tire in the car. It costs money to buy a tire and it adds to the weight. But it gives you the assurance that when you have a flat tire, you will not be stranded.

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To summarize:

• We humans love certainty because it removes anxiety as anxiety consumes a lot of resources.
• More the certainty that we seek, more the cost.
• In some situations certainty maybe desired despite the cost because it offers continuity. And it’s okay too so long as the decision has been made rationally keeping in mind the cost of certainty.

-Cheers