The Investment Scientist

Posts Tagged ‘inflation risk

images-54Recently, a prospective client of mine sent me an email asking about my thoughts on Bill Bernstein’s new book “Deep Risk.” I have not read the book yet, but I do have my own ideas about deep risk vs shallow risk.

I define shallow risk as a potential loss that you can recover from and deep risk as a loss that you cannot recover from.

Market volatility, for example, is a shallow risk. It is very visible and it is scary, there is even a TV channel devoted to it. (That TV channel is called CNBC.)

But taking on shallow risk is how you earn your investment keep. Thus, it should not be feared, it should be welcomed.

Now what are the deep risks you should ardently avoid? I can think of three: inflation risk, behavior risk and agency risk.

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MZ Capital 60/40 Model

MZ Capital 60/40 model vs S&P 500

Once I asked a prospective client how he managed investment risk.

“Well,” he intoned, “I try to get in before the market rallies and get out before it tanks.”

It is not just lay investors who have this misconception about risk management; many financial advisors equate risk management to market timing as well. One only needs to watch those advisors talking on CNBC to see that many of them are in the fortune-telling business.

So how do I manage risks? There are three steps.

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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