Book Review. Deep Risk: How History Informs Portfolio Design

Book Review. Deep Risk: How History Informs Portfolio Design

Financial Armageddon?

End of Civilization as We Know It?

Absolutely NOT!

Read my review: Deep Risk: How History Informs Portfolio Design.

by William Bernstein, MD


Many different types of Doom and Gloom aficionados have been around for thousands of years. Don’t be intimated by the financial doomers and gloomers–be inspired and encouraged with financial knowledge!


Book Review by Steve

I am a big fan and follower of Dr. Bernstein’s work. This book, however, is a disappointment. I don’t recommend it. The author made the classic mistake of ignoring human behavior and blaming permanent losses on external historical events. Therefore, I do not know Bernstein’s reason for writing this book except to emphasize the idea that investors are victims of events they cannot control.

He introduces his concepts of “Deep risk” and “shallow risk”. Deep risk results in a permanent loss of money because of extreme and profound historical events and shallow risk results in the temporary loss of money by the usual stock market volatility.

He focuses on historical deep risk events that led to permanent losses–wars, hyperinflation, Great Depressions/recessions, etc. While his historical account is accurate, how does this information help protect investors from deep losses? It adds little to “Portfolio Design”. If the planet has a global economic meltdown or WWIII, it’s Armageddon. We are all doomed and no amount of inflation-protected bonds, taking social security at 70, and implementing Harry Brown’s Permanent Portfolio will protect us from permanent losses, let alone the zombies beating down our front doors. The author seemed to imply that global civilization itself might cease to exist!


Let’s take a closer look at the author’s “Four Horsemen” of Financial Disasters:

  • Horseman #1. Severe prolonged hyperinflation occurred in Germany and other countries.
  • Horseman #2. Severe, prolonged economic recession/depression Japan since 1990. Also, U.S. during our Great Depression.
  • Horseman #3. Confiscation of assets.
  • Horseman #4. Devastation. Due to international conflict or civil war.

Horseman #1: Americans over 45 years old lived through “hyperinflation” (relative to our current rate) through the 1970s. My husband and I bought a house in 1981 that had a 2nd mortgage of 17%! We still lived and invested, inflation-protected bonds were years away. The author seems to be predicting that if it happened in Germany (and some Latin American countries), it could happen here. Okay, but Bernstein leaves the impression that we are 100% total victims of inflation. Are we? Paul Volker, the former Federal Reserve chair, doesn’t think so. He said in a recent interview about our own high inflation in the late 1970s: “It’s the behavior patterns in our head…. Economists don’t really understand. The more abstract mathematical models they use, the more they lost sight of human beings and their emotions.” If people believed that inflation would decrease, Volker believed that inflation might have normalized faster than it did.

Horseman #2. Japan’s example does not provide anything new on how its 25-year economic stagnation “informs portfolio design”. Investors around the world, including the Japanese, are currently living with their recession/depression. A simple protective strategy is to invest in the Total International Stock Market index, which would include Japan. Of course, Japan 25-year recession/depression negatively affected this index, but it’s nowhere near Armageddon. Diversified portfolio aficionados already know about the speculative risk of investing in any one country.

Furthermore, this identical diversified portfolio would protect us from Horseman #1, any country’s hyperinflation rate.

Horseman #3. Confiscation! SERIOUSLY? I did a double-take on this “risk”. Words are powerful, and confiscation of our money is one serious allegation. Confiscation is loaded with speculation that stimulates all types of powerful (and patently false) conspiracy theories. I imagined U.S. army tanks rolling down our gated community and armed soldiers entering my house (and my neighbors) demanding my password to Vanguard. Of course, my image is nonsense! The author knows tax rates after WWII all the way to 1980 were 80-90% with high-income earners. Yet, the economy was booming along during the post-war years in the United States. When those tax rates were reduced 35 years ago, the “trickle-down” theory failed and middle class incomes barely rose, while the richest 1% raked in massive increases of their incomes and subsequent wealth. I am flabbergasted by this particular deep risk example. A clearer picture, that just about everybody knows, is the transfer (aka, “confiscation”) of middle-class incomes going to the super rich and powerful with no end in sight.

Horseman #4. This is a replication of number 2. Civil wars have been localized to small countries over the years. Once again, I have a broad-based diversification plan that includes all developed and emerging markets. All of the Middle East conflicts and our own 9/11 have not permanently stopped the growth of civilizations. Our ordinary and conventionally diversified portfolio continued to grow and temporary decline during these terrible times.

mushroom cloud

Our country hunkered down and began producing more domestic oil, installing solar power and windmills and building additional energy-efficient household appliances, electric cars, increasing waste recycling and watching our power use more closely. “Deep risk” scenarios are offset by here-to-fore and unpredictable economic opportunities for investment too.

None of the disasters the author cited took on a worldwide scenario where every country and every citizen was negatively affected financially. If it did, aren’t we all doomed? If my retirement savings lose 70% permanently, and my neighbors’ savings and the entire population of savings is all lost by 70%, the economic impact would be awash in my opinion. We are all in the same boat.

A regularly diversified, low-cost portfolio filled with index funds with the stock/bond split appropriate for our age will protect us from either deep or shallow risk. I have followed Bernstein’s career for over a decade. He retired from medicine, and he advises ultra-wealthy people, worth $25 million or more. I wonder if the author and his super wealthy clients have gotten older and more paranoid about the world. I know financial professionals have been badly shaken from the 2008 financial crisis and are angry and bitter about the 2010 new regulations and Fed policy. I can only speculate how investors with $25 million or more view the world—they live in their own private world of jets, fortresses and private islands. Perhaps they are similar to my paraphrasing to what Paul Volker said about abstract economic models–the wealthier people are, the more they are vulnerable to losing sight of the stability and worthiness of civilization.

Here are other “deep risks”:

The current deep risk of low-interest rates. Every investor knows our MM investments, bank or credit union savings accounts are a cruel joke. Thirty years ago when I had a total of $6,000 saved in a bank savings account, I got $30 a month in interest each month. $30 per month was an initial experience as a young adult watching money working for me. Fast-forward to 2015, my credit union statement reported a total of 30 CENTS credit for a month’s interest on $6000 that I had in my account coincidently! I KID YOU NOT! Upon closer examination, I had a permanent loss of $400,000 in potential returns over the last eight years. Five percent interest rate of a million. $1,000,000 x. 05 is an annual income of $50,000. Instead of $50,000 I would have gotten about $125.00! I retired eight years ago for a total of 8 years x 50 grand per year = $400,000. Is this deep risk? No, it is a fact of life that investers have learned to live with.

Another well-known fact is that millions of investors capitulated during the 2008 crash and transferred their money into MM accounts and never got back in stocks. Those investors are scared. Their behavior of getting out at low prices because they couldn’t stand it any longer (or more likely is that they took on more risk than they should or did not have a plan) is the primary reason they have permanent loss. Human behavior during these terrible times should be considered as legitimate deep risk. All the great investors of our time (Buffett, Bogle, Lynch, Swedroe, Ferri, Bogleheads, etc.) said that humans are our own worst enemy, not the markets, countries, Wars, hyperinflation, or anything “out there”.

Other facts of life losses are divorce, permanent illness of the primary wage earner or early death from diseases, accidents, or loss of home and business from natural disasters. Stuff happens. Still, investors with a low-cost, diversified portfolio with Vanguard can live through these real losses and rebuild their lives with the help of property, life and disability insurance.

Finally, do I dare say that there are benefits from losing money permanently. Absolutely. IF you can look deeply into the abyss in your psyche, learn, and take responsibility for financial mistakes. My late hubby and I lost over a million in the 2000-2002 tech bubble, and about a third had never recovered. We simply altered our damaged ego and our monetary loss to a tuition payment. Sure, it was expensive! But this experience was a perfect lesson directly from the “school-of-hard-knocks” which turned profitable eventually. Our learning turned out to be worth a lot more than the $350,000 permanently lost after the tech bubble crash. We properly diversified our portfolio with a healthy allocation to bonds, when in turn saved us when Mr. Bear returned with a vengeance in 2008. Subsequently, we learned so much in our tech wreck, we saved in investment costs, avoiding additional losses in 2008 by using indexes and Vanguard. We made up for that “permanent” loss in the last eight years, despite this low-interest rate environment I mentioned.

I am disappointed in this book for its lack of purpose other than to scare ultra-wealthy individuals and their advisers from the taxman. Thank goodness, taxes are the least of my worries, as my tax rate is lower. While I am financially comfortable, I am not close to being  ultra-wealthy.

The bottom line-many personal financial books report that forces “out there” are less risky than our own human behavior. History and the author’s “deep risk” do not inform portfolio design–it is what we do, rather than what negative external events do to us.

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