The past is known, the future is unknown.

I have made up this simple mantra to denote something exceedingly tricky in the financial arena, which is how much do we look backwards to work forwards?

An obvious example of this is that I can tell you exactly how the US stock market has performed in the past ten years, whereas I have to admit (as does every other adviser and person on the planet) we have no idea at all how it will perform in the future.

You know if you have not had a house fire in the past ten years, but how do you know you won’t in the next ten years?

Looking at it this way, the past is irrelevant, as we cannot assume anything about the future by extrapolating from the past.

Yet, that would be ridiculous otherwise we would never learn anything. Our brains are literally wired to form memories to help us predict future possibilities.  That’s the end of the neuroscience for this article, but if a structure as complex and astonishing as our own brains, links the past to the future in this way, then why shouldn’t we do the same when we come to make decisions about our finances? After all, we are in many ways, the physical manifestation of our own brain’s.

If the brain can legitimately be seen as a predicting “machine”, then we are left with one question. What’s the best basis for weighing up probabilities that help us make good predictions, on balance and over time?

The answer lies in combining two somewhat related, but also somewhat separate, financial decision making “devices”.

The first is to take the known and check how much the conditions in front of us represent the same sort of conditions that existed within the past. If the answer is there is nothing obvious to suggest a radical change, then we can rely to some extent on extrapolating. Hence, why we keep investing some of our money in the US stock market, if that is suitable to our wider objectives.

The second is, and this is the cornerstone of all great financial planning, to take out insurance, either explicitly (e.g. fire insurance on our home) or implicitly (have diversification when we invest).

This is the way we accept the unknown and still aim to navigate it, come what may.

This is why insurance is so important. It allows us to work with the past and take the knowns and apply some assumption to the veracity of the information, but then respect things could change and be different.

Insurance is the ultimate risk management device, and whilst it is widely used, is also commonly treated like an irritable necessity.

In many cases, I would list insurance as the number one item on any agenda when decisions are being taken by families and businesses.

A great financial planner will make this the number one item in any discussion, ahead of any decision.