Deep Risk & Shallow Risk: An Overview
Is your portfolio on the mend from the tumultuous past few years? The recent upwards trend in global and national equity markets is indeed encouraging, but data suggests that individual investors are more cautious than prior to the recession of 2008. They have good reason to be concerned. Many portfolios suffered damaging losses during the recession period, and while recovery is nice, many people are still fighting to recover.
The after effect of the crash of 2008 is that we tend to be more cautious about big financials and equity traders than before. We also tend to view our investment strategy a bit more conservatively. However, the real lessons to be learned from the recession are the importance of balance and the need for accurate and reliable information.
Many investors who had balance in their portfolios have recovered relatively well. Investors who had access to real-time information are also prospering. The great divide between those individuals and the rest of us is steeper than ever. Information and balance make for a solid investment tandem.
Understanding and Identifying Risk
A certain amount of risk is unavoidable. After all, you cannot outpace the market or inflation with low-interest securities. Yet, every portfolio is different, as is every individual’s appetite for risk.
In understanding risk, most investors would benefit from distinguishing “shallow risk” from “deep risk.” This understanding is essential to building the balanced portfolio.
Shallow risk is a temporary drop in the value of an asset. The definition was first attributed to noted analyst Benjamin Graham who referred to this type risk as “quotational loss.” Graham stated that quotational and shallow loss was inescapable, comparing it to the weather. Shallow loss must be expected and managed through a system integrated with offsetting strategies.
Deep risk is a bit more intimidating. We have recently experienced deep risk and deep loss. When accepting deep risk, the investor must be prepared to live with the loss for decades after inflation is figured.
In a new e-book entitled Deep Risk: How History Informs Portfolio Design, the author says; “Imagine that you are a homeowner with a fixed annual insurance budget. If you live in a dry part of Kansas, you probably should tilt your insurance spending toward tornado and fire coverage; if you live in Southern California you should cover earthquake and fire first; along a river, flood insurance matters most.” This provides excellent imagery for the shallow risk, deep risk elements of a portfolio.
According to Bernstein, “inflation, deflation, confiscation and devastation forces can make assets lose most of their value and never recover.” This fact is a problem for the individual investor.
If we are protecting against deep risk, we must be aware and understand:
Devastation – The impact of war or anarchy on economies.
Confiscation – Usually prompted by a surge in taxation, seizure by a bank or government can be devastating. If you think this no longer happens, take a look at recent events in in Cyprus and you will realise that large scale confiscation does still occur.
Deflation – The persistent drop in asset value is rare but you only have to look at what is taking place in Japan to see the risks that deflation poses.
Offsetting Risk
For each of these symptoms, there are offsetting strategies. The implementation of these strategies can assist in mitigating the risk. Financial planners are expert at understanding risk and implementing products that mitigate the risk. The number of available products offered by today’s planners and financial consultants is varied.
For more information about the financial planning services that we provide at Expert Wealth Management, get in touch by calling 01993 772467. You can also contact us online.