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Tuesday, September 24, 2013

Review: Deep Risk

William Bernstein has written a new series of short books titled "investing for adults". Deep Risk is one of the series. The book is short, and I wish Bernstein had simply cobbled all the books in the series together as one book rather than trying to sell each monograph separately.

The idea behind Deep Risk is that there are 4 major potential disasters (Bernstein refers to them as the Four Horsemen) that can derail your financial plan. These are: inflation, deflation, confiscation (taxes), and devastation (war). He then analyzes them in terms of how frequently they occur and how difficult it would be to insure against them.

It shouldn't surprise anyone that inflation is by far the most common potential problem for any portfolio. What's interesting about Bernstein's analysis is that he discovers that the traditional inflation protection, Gold bullion, isn't actually very good as an inflation hedge! Rather, stock portfolios tend to do far better as inflation protection even though in the aftermath of an inflation, the stocks could do badly. Bernstein dismisses the potential short term underperformance of stocks as shallow risk: in other words, if you had the fortitude to hang on, you'd recover your portfolio with no permanent loss of capital.

Deflation is much less likely, and Bernstein claims that it has only happened once in Japan since developed countries went off the gold standard. He dismisses Japan as a one off. I disagree, as the U.S. came close to adopting the very same policies that Europe did and could have gotten 10 years of deflation as well. It's also not clear to me that Europe hasn't been subject to the same deflationary problems. Bernstein claims that gold is actually a great deflation hedge, since a big depression triggers a flight to safety, which is what gold traditionally is.

Bernstein defines confiscation relatively loosely. For instance, an increase in tax rates could be defined as confiscation. It seems to me that you could solve the confiscation relatively easily, by moving to a very high tax state with already confiscatory taxes, at which point your risk of further confiscation is relatively low. To be fair, Bernstein does point out the exiting U.S. citizenship would cost you an exit tax, and even holding foreign assets is no protection from the tax man, should we ever get an administration that chooses to enforce such laws. The reality is, if you're a U.S. citizen intending to stay in the U.S., there's relatively little that you can do beyond the existing well-known tax-sheltered accounts and tax-managed funds.

Finally, the threat of war is real, but again, there's relatively little you can do unless you decide to become a survivalist and start building bunkers. In serious threats, what you'd have to do is to stockpile food, guns, and ammunition and build a private army. Historically, people who've done that don't tend to do all that well financially, and the existence of events such as the Waco Seige indicates that even building your own private army doesn't do very good if someone with a real army chose to take you out.

Ultimately, I found the entire book disappointing and lacking in useful action items. The truth is, as a financial observer I've found that far more people have devastated their portfolio by panicking during a crisis than by having their wealth confiscated by a government, war, or even inflation. So rather than writing a series of books called "investing for adults", Bernstein probably should have written a book about how to become an adult, as far as investing is concerned. Not recommended.

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