There is one ball player out there who has cracked the nut of investing -- a guy who grasps the underlying complexities of the financial world with astonishing ease. Even though I've never heard him utter even one market catch phrase or a single financial buzzword, it's clear that this guy just gets it.

Do you know who he is? Let me help you out.

First, I assure you his name does not rhyme with Denny Lykstra -- who clearly doesn't get it.

I doubt that the guy I'm thinking of has ever played with a Bloomberg terminal, made a call on a stock, or managed a dime of anyone else's money. Yet this man is able to grasp abstract concepts like risk and uncertainty better than most risk-management officers on Wall Street do.

His name is Yogi Berra, and he's awesome.

Admit it. You already like him.
If you made a list of quotable people who also happen to be athletes, this name should fall near the top. But there's a whole lot more to Yogi Berra than just an amusing quip or a clever taunt. He seems to harbor an innate understanding of risk and chance. Examine the following statements:

  • "The future ain't what it used to be."
  • "A nickel ain't worth a dime anymore."
  • "I knew the record would stand until it was broken."

In three terse sentences, Berra captures the central ideas behind a few big investment problems:

  • Predictions are rarely accurate.
  • The dynamic between price and value is always changing.
  • When you're dealing with an uncertain future, nothing is written in stone.

These are basic yet crucial investing principles. And although Yogi hasn't physically mastered the market -- at least, that I know of -- his ability to speak with this kind of elegant simplicity is unique.

What would Yogi think?
This makes me wonder what Yogi would say about a recent article published in the Wall Street Journal, which discussed the failure of Monte Carlo models (and the financial advisors using them) to anticipate the financial disaster of late.

The Monte Carlo simulation, for those who don't know, takes various inputs, runs them against randomized simulations, and then throws the results together into a statistical model. If you haven't heard of this process, perhaps you should ask your financial advisor, wealth manager, or investment bank about it, because someone who touches your money has probably been using this software to model risk in your portfolio. The results of these simulations are then used to answer a rather crucial question: Will you have enough money to survive once you retire?

Suspicion tells me that Yogi might have a problem with a machine that's meant to predict the future.

Despite the elaborate complexity of these models and all of the theoretical science involved, financial simulators are all flawed in one simple way: The future is, by definition, unknown. So you can't really model it. You can try, but it won't work.

Yogi already knows this. Sadly, most financial advisors don't.

Where it all went wrong
Humans and models together failed to anticipate our recent market collapse. Don't blame the models, though. After all, a simulator can be only as good as the person who calibrates it.

In addition to false assumptions regarding "normalized" statistical distribution of stock market returns (and I promise not to get more technical on you than that), I'm nearly certain that the folks who coded these simulations -- as well as those using them -- further rationalized that the U.S. markets were too stable and had too many fail-safes in place to experience a 50% drop such as the one we've just experienced.

And therein lies the problem. Of all people, the individuals calibrating these simulations should be the most familiar with how probable a 50% market drop truly is. And regrettably, they were not.

The market does crash
Drops on the scale of 50% are unusual, but they're not out of the realm of possibility. In fact, they happen a lot more frequently than we'd like to believe. Think about it: We've had numerous double-digit swings in this decade alone.

I can't help feeling that the simulations as they were set were a lot like a flight simulator that doesn't offer a "landing in a thunderstorm" scenario. Thunderstorms happen more often than 50% drops in the stock market do, but either one can result in the same thing: bad, bad landings.

If you examine the historic returns of the stock market, you'll ultimately conclude that if you're alive on this planet for more than 20 to 30 years, it's more than likely you'll experience a huge drop in the stock market. So why the heck didn't these models account for that fact?

Choose to acknowledge reality
The reality is this: Massive volatility is here, always has been here, and probably always will be here.

Please forget doing what these financial advisors are trying to do. Don't attempt to predict the future and make investments based on these predictions. No one really knows what the future is going to look like, even (and perhaps especially) the experts. The market will go up, and it will go down -- everything else is uncertain.

Next, don't trick yourself into thinking that any individual assumption about the future, no matter how safe it may seem, is a 100% lock. Need evidence? Check out some of these more recently infamous assumptions:



2-Year Return

General Electric (NYSE:GE)

Great investment. Safe. Stodgy. A well-insulated superconglomerate.


Fannie Mae (NYSE:FNM)

Largest owner of American mortgages. Enjoys pseudo-governmental protection and has direct access to the strongest, most-secure assets in the world -- American homeowners.



Biggest provider of insurance services in the world. Safe. Conservative. Profitable.


Citibank (NYSE:C)

Largest global bank, offering a full suite of financial services. Extremely well run and very well protected.


Five years ago, someone would have provoked laughter at the suggestion that these five businesses would end up in their current state. Perhaps you should consider similar assumptions that people are making about supposedly supersafe stocks ... whether it's McDonald's (NYSE:MCD) or Wal-Mart (NYSE:WMT) or whatever. It's really not much different in these cases. Apple (NASDAQ:AAPL) may seem invincible, but it's not. Anything can happen.

Three steps to control risk
It's in your best interest to calibrate your own portfolio to account for the stock market's lack of certainty. How?

  1. Don't make outsized bets on any one investment if you can't afford to lose 100% of your money. It's the stock market, folks. Your money could all get wiped away before you can do a thing about it.
  2. Next, don't count exclusively on having one or two things going right with your investment, when so many things can go wrong. Avoid situations in which a precious small number of things must go right for your investment to succeed.
  3. And finally, stay away from investments that you truly don't understand. You can never find a sure thing, but you can certainly push the odds in your favor.

The Foolish final word
Yogi Berra once said, "It ain't over till it's over."

If you're investing as if the future is a foregone conclusion, then you might just find yourself the unfortunate victim of a bad assumption. Don't let that happen. Diversify yourself across a bed of the world's best companies. No one can guarantee success, but the odds are substantially in your favor if you at least diversify. And that's how you make more money without seriously risking losing all of it.

You can find the world's best companies with the Motley Fool Stock Advisor service. Our 70-plus recommendations have combined to crush the S&P 500 by more than 38 percentage points over the past seven years, so the strategy is clearly working so far. You can click here to test out the service absolutely free for 30 days. This is a no-risk proposition.

Nick Kapur loves talking risk and has an active position in an inverse S&P 500 ETF to reduce risk in his portfolio. Apple is a Stock Advisor recommendation. Wal-Mart is an Inside Value pick. The Fool has a disclosure policy.