Decision-Making Under Uncertainty: Why We Crave Certainty and How to Navigate It - Behavioral Finance Series

“We are wired to believe we can predict the future. Yet in investing, the future is rarely knowable—and our own minds are often the loudest source of illusion.”

Imagine standing at a crossroads. One path is well-lit, crowded, and everyone around you seems confident. The other is foggy, quiet, and uncertain—but may lead to opportunities you cannot see. Most of us instinctively follow the crowded path. It feels safe. It provides social proof. It reduces anxiety.

This simple human tendency—our craving for certainty in an uncertain world—pervades every investment decision. Yet financial markets are inherently unpredictable. They are complex adaptive systems shaped by human behavior, feedback loops, and unexpected shocks. The real skill in investing is navigating uncertainty intelligently, not pretending we can eliminate it.

The Human Need for Certainty

Humans have an evolutionary wiring for certainty: knowing what is likely to happen reduced danger in ancestral environments. In financial markets today, the desire for predictability can lead to poor decisions.

Theoretical Foundation: Knightian Uncertainty

Frank Knight (1921) distinguished between:

1. Risk: Situations where probabilities are known (like a roulette wheel).
2. Uncertainty: Situations where probabilities are unknown, and outcomes are unpredictable (like financial markets).

Most of investing occurs in Knightian uncertainty. Our brains, evolved to handle small-scale risks with known probabilities, are ill-equipped for the ambiguity of markets. This mismatch drives overconfidence, overtrading, and the constant search for “sure things.”

Social Validation and the Preference for the Visible

Humans also seek social validation—we prefer paths others take because it reduces the emotional cost of being alone. In markets:

1. During bubbles, investors pile into the same hot sectors because everyone else is buying.
2. In crashes, panic selling spreads rapidly, not always because fundamentals changed, but because social proof amplified fear.

Example: During the 1929 U.S. stock boom, investors bought stocks simply because “everyone else was making money,” ignoring valuation fundamentals.

Cognitive Biases That Distort Decision-Making

Behavioral finance explains how our brains respond to uncertainty. Key biases include:

Overconfidence

Believing we know more than we do. After short-term gains, investors overestimate skill, increase leverage, or chase trends.

Example: Many investors entering the dot-com bubble assumed they “understood” tech valuations—until the crash wiped out wealth.

Illusion of Control

Belief that our actions can influence outcomes we cannot control. Portfolio tinkering, market timing, and trading on hunches are examples.

Example: Leading up to 2008, financial institutions believed their risk models gave them control over mortgage-backed securities, ignoring systemic fragility.

Probability Neglect

Humans misjudge rare events: either underestimating them (“it won’t happen to me”) or overreacting (“the world is ending”).

Example: Few anticipated COVID-19’s market impact, while others overreacted to minor news events, triggering unnecessary portfolio shifts.

Loss Aversion and Disposition Effect

From Prospect Theory (Kahneman & Tversky):

1. Losses hurt more than equivalent gains feel good.
2. This drives panic selling of losers and premature selling of winners (the disposition effect).
3. These behaviors undermine probabilistic, long-term thinking.

Why Craving Certainty is Dangerous

The financial cost of seeking certainty is real. Emotional, reactionary investing reduces returns:

1. Quantitative Evidence: DALBAR’s 2025 Quantitative Analysis of Investor Behavior shows that in 2024:
2. Average equity fund investor return: 16.54%
3. S&P 500 return: 25.02%
4. Behavior gap: 8.48% (848 basis points)
5. This gap reflects losses from panic selling, trend chasing, and other certainty-driven actions.
6. Leads to reactive decisions: Investors abandon strategies mid-crash or chase short-term trends.
7. Exacerbates stress: Emotional reactions amplify fear and greed.
8. Masks true risk: Confidence in predictions can blind investors to rare but catastrophic outcomes.

Historical Examples:

1. Dot-com Bubble (1999–2000): Certainty in “new economy” stories led to massive losses.
2. Japanese Asset Bubble (1980s): Overconfidence and narrative-driven investing caused a decades-long stagnation.

Embracing Optionality and Reducing Fragility

Since certainty is impossible, the goal is to structure decisions for resilience and opportunity.

Optionality

Definition: Setting up decisions to benefit from positive surprises while limiting downside.

Examples:

1. Barbell strategy: Most capital in safe assets, small portion in high-upside, high-risk opportunities.
2. Staggered entries: Gradually investing to maintain flexibility.
3. Rights vs obligations: Investments that provide options, not forced commitments.

Example: During early COVID-19 market drops, investors with optionality bought undervalued assets while others liquidated under stress.

Fragility Reduction

Definition: Reducing exposure to events that can cause large losses.

Techniques:

1. Avoid leverage that can amplify losses.
2. Diversify across sectors, geographies, and asset classes.
3. Hedge catastrophic exposures without overpaying.

Example: Many institutions collapsed in 2008 due to high leverage, while conservative, diversified portfolios survived and recovered faster.

Robust vs. Antifragile

1. Robust: Survives shocks without change (e.g., diversified, low-leverage portfolio).
2. Antifragile: Gains from disorder (e.g., barbell strategies, hedges, cash ready to buy during panics).
3. Optionality and fragility reduction together allow investors to be robust or antifragile, depending on goals.

Structured Reflection and Emotional Discipline

Investing Under Uncertainty is Improved by Mental Scaffolding

“Mental scaffolding” is a metaphor for building structured mental frameworks that support your thinking, much like physical scaffolding supports a building under construction. In investing, it means deliberately creating habits, rules, and thought processes that help you make better decisions before emotions or chaos take over. Rather than relying on gut reactions or hoping for forecasts to be right, mental scaffolding prepares you for uncertainty and guides you to act consistently.

Key components include:

1. Pre-Mortems: Before taking an investment action, imagine all the ways it could fail. Ask yourself: “What could go wrong?” This helps identify risks you might otherwise ignore.
2. Kill Criteria: Convert vague worries into clear rules. For example: “If this stock falls 20% over two months, I will sell.” These objective triggers prevent emotional panic.
3. Scenario Planning: Instead of predicting a single outcome, consider multiple plausible futures. For example, imagine how your portfolio would react to a market crash, rising interest rates, or geopolitical shocks.
4. Pre-Habbing: Mentally rehearse how you will respond to stress. Say to yourself: “If the market drops 30%, I will rebalance according to my plan, not panic sell.” This builds emotional resilience and reduces impulsive reactions.
5. Probability-Weighted Thinking: Evaluate both the likelihood and impact of each scenario. Focus your attention proportionally—rare events matter, but probable outcomes deserve most of your energy.

In short: Mental scaffolding is about preparing your mind and your plan so that when uncertainty hits, your actions are deliberate, not reactive. It turns fear and chaos into structured responses, letting you stay calm, disciplined, and positioned to benefit over the long term.

Real-World Applications

1. 1929 Crash: Investors ignored systemic risk, overconfident in rising prices; those with diversified portfolios survived.
2. Japanese Asset Bubble (1980s): Overconfidence and certainty-seeking led to decades-long stagnation.
3. COVID-19 Market Shock (2020): Optionality, liquidity, and scenario planning allowed some investors to buy at historic lows while others panicked.

Lesson: History rewards those who prepare for uncertainty, not those who chase certainty.

Practical Frameworks for Navigating Uncertainty

Key Insight

All these frameworks work together like a toolkit for thinking under uncertainty:

1. Optionality and fragility reduction help position your portfolio.
2. Robust vs. antifragile thinking helps you decide how to survive or benefit from volatility.
3. Scenario planning, pre-mortems, pre-habbing, and probability-weighted thinking help structure your mind and decisions, reducing emotional mistakes.

Put simply: these frameworks turn uncertainty from a threat into an opportunity, and your portfolio and mindset become stronger, more disciplined, and more flexible.

Key Takeaways

1. Certainty is psychological, not practical. Markets are unpredictable.
2. Biases are predictable, not fatal. Overconfidence, probability neglect, and illusion of control can be managed.
3. Optionality > prediction. Structure decisions to survive and benefit from volatility.
4. Reduce fragility. Survive extreme events first; gain optional upside second.
5. Structured reflection beats reaction. Pre-mortems, scenario planning, and pre-habbing reduce emotional errors.
6. Embrace uncertainty as opportunity. Calm, deliberate navigation outperforms emotional reaction.

Closing Thought: Transitioning to a Preparative Mindset

Investing under uncertainty is less about predicting the future and more about preparing for it. Move from a Predictive Mindset—seeking certainty, relying on forecasts—to a Preparative Mindset—embracing uncertainty, building robust/antifragile systems, and rehearsing disciplined responses.

Ask yourself at every decision:

1. Am I creating optionality?
2. Am I reducing fragility?
3. Have I mentally rehearsed my response to the worst-case scenario?

Those who answer yes consistently—not perfectly—are the ones who thrive over decades, regardless of market noise, crises, or narrative swings.