A few days ago, I read an article in the Wall Street Journal by Jason Zweig titled “’Shallow Risk’ and ‘Deep Risk’ Are No Walk in the Woods.” I like Zweig’s writing; his Intelligent Investor column always has something interesting to say.
In the article, Zweig describes an upcoming e-book by William Bernstein in which he describes two kinds of risk—obviously, shallow and deep. Shallow risk is a temporary drop in an assets price. It’s the normal ups and downs of stock prices, particularly when the price of the asset drops. Zweig says (and I agree) that shallow risk is as inevitable as the weather. Although shallow risk can definitely be painful and can last a while, it’s just not permanent.
Deep risk, on the other hand, refers to risks that are systemic and permanent; Bernstein cites 4 possible causes of deep risk: inflation, deflation, confiscation and devastation. In other words, big bad things that can happen. Devastation and Confiscation refer to wars, government collapse, seizure of assets and so on—bad things that are out of our control. Deflation is rare in modern history, so the only remaining concern that you can protect yourself from is inflation. Zweig, quoting Bernstein, says that the best insurance against inflation is a globally diversified portfolio.
The thing that I thought most interesting about the article is where Zweig indicates that traders and investors can turn shallow risk into deep risk. How’s that? If you watch a trade go against you, and see your equity drop, you are experiencing shallow risk. If you panic, and sell at the bottom, you inflict a permanent loss of capital on yourself. The shallow risk is now permanent. That’s deep risk.