"Deep Risk: How History Informs Portfolio Design" is a book by William Bernstein, Ph.D., M.D., a retired neurologist from Oregon. Bernstein is also the co-principal of Efficient Frontier Advisors. He has authored a number of books on finance, including: "The Ages of the Investor," "Skating Where the Puck Was," "The Investor's Manifesto," among others.
Don’t confuse the writer with Peter L. Bernstein, known for "Against the Gods." I made that mistake, although I don’t regret it.
Risk is a subject that fascinates me as together with return, it is everything investing is about. Yet it is a confusing subject, with academics using it to refer to price volatility while you and I refer to it as the chance we lose money. The first thing you need to do when discussing risk is define what it means, at least for the duration that you are discussing it. Bernstein does so and divides up risk in a novel way – into Deep Risk and Shallow Risk.
Deep Risk – a permanent loss of real capital – is basically the risk that you underperform against your expectations for a very long time, and there is basically no solid path to recovery. Shallow Risk means short-term price fluctuations.
One of the problems with Shallow Risk is that it tends to feel like you are experiencing a Deep Risk. This novel division of risk is an interesting way to think about it and perhaps helpful to some people when trying to stay the course or to calm their nerves when the markets hit an air pocket. I don’t think it is a perfect definition, but that doesn’t mean you can’t learn anything from the book.
Bernstein is not shy about giving practical tips how to deal with the short term price fluctuations that are inevitable to market participants but basically it all comes down to staying disciplined and remaining patient. This isn’t the interesting part of the book.
Why you should read this
Much more interesting is Bernstein’s dissection of Deep Risk, which is the subject of the book. Bernstein likes to categorize and divides the Deep Risks into subsets again:
- Inflation.
- Deflation.
- Confiscation.
- Devastation.
These four type of risks can really hurt your portfolio of assets. The obvious solution that Bernstein uses as an example of how not to protect yourself against these risks is by allocating 25% of your portfolio to assets that are resilient to each risk.
Instead he examines the likelihood of each risk occurring and recommends tying your allocation to that. He serves up a lot of interesting data to support his argument, and this is one of the reasons why I like the book. Some of the allocations/solutions he discusses are quite impractical after which he dismisses them and looks for better ones. Storing coin or gold in foreign bank vaults is not the most practical thing.
I felt his discussion of devastation was a little lacking as it kind of came down to the old when it happens, money isn’t really your problem. I think that’s something of a shortcut. Obviously with some catastrophes it doesn’t really matter what kind of assets you have left, but there are many events imaginable where a little preparation will go a long way. You won’t find them here.
One surprising conclusion that he draws from his data is that bonds perform very poorly when faced with Deep Risk. The one category that stands out somewhat are TIPS. Ultimately the conclusion I reached at the end of the book is that I’m well-positioned with my value tilted equity portfolio that contains quite a few foreign stocks and has a bit of exposure to commodity producers and the price of gold.
"Deep Risk" is a short and easy read that offers compelling evidence to construct your portfolio a certain way and it is easily worth its cover price. I would recommend a book like "The Black Swan" more highly than this one, but this one wins in terms of practical actionable advice.
