Deep Risk by William Bernstein

[gerntz]

Quote:

Originally Posted by MichaelB Just finished reading William Bernstein’s new booklet, “Deep Risk: How History Informs Portfolio Design” This is part of his (aptly named) series “Investing for Adults” Investing for Adults. This new booklet (only 51 pages) was first highlighted by Jason Zweig a few weeks ago in the WSJ blog http://blogs.wsj.com/moneybeat/2013/...-in-the-woods/ , who gives a very good summary. It is an excellent high level discussion of financial risk, which he categorizes in a way that makes sense to non-financial professionals and would easily fit into many forum discussions. After describing the primary causes of financial loss he presents his view of the likelihood, impact, recoverability and recommended investing strategy for each. He sees inflation as particularly dangerous and fixed income as deeply exposed, recommending a “globally value-tilted diversified portfolio, perhaps spiced up with a small amount of precious metals equity and natural resource producers” as the safest investment over time. The ebook price is $5, and Amazon Prime members can borrow it.

His "The Intelligent Asset Allocator" has been my investment bible for 15 years.

As for, "He sees inflation as particularly dangerous and fixed income as deeply exposed, recommending a “globally value-tilted diversified portfolio, perhaps spiced up with a small amount of precious metals equity and natural resource producers” as the safest investment over time.", my passive investing advisor has kept bond fund durations low, is firmly in the global & value camp, and spices me with GLD & gas transmission MLP's. Maybe he reads Bernstein?

[haha]

I finished this short book, and will go through it again before I pass it back to Amazon. A few things jump out- this advice is not just more of the same asset 60:40 or 50:50 stock:bond asset allocation, and save 25X spending before retirement. This is a lot more demanding. He says that if you are not working, you should have 15-20 x your (expenses-(SS and pensions)) in liquid and ultra safe investments like T-bills and short term liquid notes and CDs. Now remember that these investments are designed to guard against shallow risks, which are relatively short term, but will leave one heavily exposed to deep risks which tend to be longer term, but may actually come suddenly. He more of less suggests that retired people must design to deal with shallow risks, no matter what other risks may be left unguarded.

It seems that if this book is taken to heart, and if a secure retirement is something you want, run, don't walk to get a government job if you can. Otherwise save enough for your chosen SWR, but also save another 15 -20 x(expenses not covered by COLA annuities). So non-govt workers had better have very good jobs, or no life, or both, while they try to put together this huge amount of retirement funds.

And remember, your taxes will have to answer to very powerful public unions, and very active and empowered "poor people" who might prefer that you do their retirement planning and saving for them. (Hey, it's only fair!) Millionaires paying close to 0 FIT will likely not be a long term condition, no matter how clever their tax planning

Ha

[Running_Man]

Yes an unusual take on retirement'
"Shallow risk requires deep liquidity", is one of the first statements made, as is a discussion of the Harry Browne Permanent Portfolio, after which the book begins to take a non- academic look and becomes political in my mind, calling gold investments "creepy". Indeed even as he mocks the Permanent Portfolio over and over again and attempts to improve it by the tried and true method of adjusting for substitutes, he appears to realize that Harry Brown's Permanent Portfolio actually did what he said it would, but then I guess because it lost money in 1975 it is not actually of value.

In arguing for stocks, he makes the classic mistake of stating that if one had stayed in stocks throughout WWII in Germany by the 1950's you would have been ahead of the game. The truth is if you stayed in Germany and had wealth prior to WWII, you most likely were dead or destitute by the end of that war. If you owned stocks, the government had a record of your investments and would confiscate them when you tried to leave Germany during WWII. The important point to realize is if you have a crazy leader in your country and they are railing against the class of people you belong to, LEAVE!!.

If one held gold in trust oversees, one could have escaped this madness. When Germany invaded Poland 3.3 million Jews lived in Poland, many tried to escape but did not have the financial wherewithal. By the end of WWII 300 thousand were alive.

Bernstein's faith in common stock asset allocation and enough "liquid assets" misses Harry Browne's entire take on this, even though he ends his book in somewhat of an endorsement of Craig Rowland's permanent portfolio.

The discussion of asset allocation during the 1929- 1932 was also laughable to me as he says the discussion was purely theoretical and there was no way to do it at the time, which by default makes the discussion a non-starter. Indeed his discussion of what Benjamin Graham stated in Forbes in 1932 is so true that Bernstein appears unable to grasp the statement in a meaningful way to today's investing, "Those with enterprise do not have money, those with money do not have the enterprise".

To provide a solution to problems of the past, that were not available, and to basically use them as a means for back tested partial portfolio advice, without sticking a firm stake in the ground allows Bernstein in the future to claim to be correct no matter what happens. No one in 35 years will be able to write a book and compare in detail their method to Bernstein's as he did throughout this book with the permanent portfolio. I find this cherry picking of the highest order and the idea of having 20times assets in liquid funds equivalent to Steve Martin's advice on how to become a millioniare, "First get a million dollars....".

[siamond]

I did a second pass on the booklet, reflecting on the statements that struck me the most, this all seems very sensible (as expected from Dr Bernstein), but... there is one part I don't quite get. Why does the author keep suggesting some precious metals (e.g. gold) in the portfolio?

For both inflation and deflation deep risks, he's suggesting multiple other mechanisms (e.g. international diversification, a good deal of stock, etc) which seem much more effective, as well as beneficial for improving returns (you know, things do go well sometimes! ).

As to confiscation/devastation, clearly PMEs in your portfolio won't help.

Personally, if precious metals would find a small place in my portfolio, it would be to play the rebalancing game and also to have some money to spend in those times when the market tanks all over the place, stock & bonds alike, and people panic going to gold, hence PME is the only asset going up. But that's shallow risk, not deep risk...

I must have missed something. Views?

[daylatedollarshort]

For what is it worth, here is a list of the top 10 assets owned by millionaire households ($2M+) in the U.S. based on estate tax data, 2007 - 2009. Publicly traded stocks are 12.9%:

The Top Ten Assets Owned by Millionaires

[Gatordoc50]

Quote:

Originally Posted by daylatedollarshort For what is it worth, here is a list of the top 10 assets owned by millionaire households ($2M+) in the U.S. based on estate tax data, 2007 - 2009. Publicly traded stocks are 12.9%: The Top Ten Assets Owned by Millionaires

Interesting. I wonder what the 11% in retirement assets represents. If those are also invested in the market then about 25% of assets are invested in stocks/bonds. That's about where I am.

[MooreBonds]

Quote:

Originally Posted by daylatedollarshort The Top Ten Assets Owned by Millionaires

Just as it is with people of lesser means, just because someone is a millionaire, it doesn't mean that they're automatically good with investments or money management. Some of them may be millionaires in spite of some of the assets they own.

[Gatordoc50]

Quote:

Originally Posted by MooreBonds Just as it is with people of lesser means, just because someone is a millionaire, it doesn't mean that they're automatically good with investments or money management. Some of them may be millionaires in spite of some of the assets they own.

They may not fare any better or worse than the average investor in terms of returns but it appears they are more diversified. I've often opined that having all your assets in stocks/bonds is poor diversification.

[Lsbcal]

Quote:

Originally Posted by siamond I did a second pass on the booklet, reflecting on the statements that struck me the most, this all seems very sensible (as expected from Dr Bernstein), but... there is one part I don't quite get. Why does the author keep suggesting some precious metals (e.g. gold) in the portfolio? ...

I have not finished the book but from past Bernstein books he likes to take on some slivers of PME and other diversification assets. He used to call himself sort of an asset allocation junky ... or words to that effect. I don't think he recommends much of this stuff.

[Lsbcal]

In recent times Bernstein has suggested that fixed income be very short term (duration = months not years). I have not finished this book but I'll be curious to see if his writings support this current FI view.

[clifp]

I love Berstein's investing for adults series.
I took his criticism about the Permanent Portfolio were far more directed at the advocates of it than at Harry Browne or the concept itself. I also agree with Berstein that probabilities of the potential disasters are dramatically different. So the 25% AA to each component doesn't make a lot of sense.

The key take away for me is the time to buy bonds is after inflation occurs and fears of additional inflation is at their highest. that at least gives me a target to look for when timing my bond purchases.

I was very happy to see he provide some hard data on the illusion of safety on sovereign debt. Something I've been harping on for a few years.
I agree that the US is relatively immune to military devastation, but we aren't immune to the other risks especially inflation.

The psychological difference between having a 50/50 portfolio and 75/25 back in 1929 was pretty interesting. Berstein's point was that 75/25 retiree would have had hard time committing his funds in in 1932 when market was at his bottom.

I had the same experience back in Jan 2009 when I committed the last of my cash reserves. It was the only oh **** moment of my retirement when I realized that I was not only out of cash, but if the market went further I need to come up with another 200K to pay off my long term put that I wrote.. After that I ended up sticking ~100K in a CD ladder where I won't be tempted to buy cheap stocks.

[brewer12345]

Quote:

Originally Posted by Gatordoc50 Interesting. I wonder what the 11% in retirement assets represents. If those are also invested in the market then about 25% of assets are invested in stocks/bonds. That's about where I am.

So what else do you own? Real estate?

[daylatedollarshort]

I don't have any idea what kind of portfolio will do best going forward. I just think authors that change their opinions on the best way to invest over the next 40 years based on what has happened over the last 4 or 5 years, probably don't have any more of a clue than I do. They are just going along with recency bias.

I don't think studying existing millionaires provides all the answers on the best asset allocation for the future, but it does provide some food for thought and another data point to consider.

I have found it interesting that in the Thomas Stanley research I've seen, most millionaires don't have a huge percent of assets invested in stock mutual funds -

"The problem with mutual funds is that every year they've got to declare a dividend, and you're going to pay tax on that. The wisest investors, and the majority of the millionaires we've interviewed, are people who own stocks directly and don't trade much. They're not taking capital gains. They're not taking dividends. They're building a portfolio. Other unrealized income might come from a business. You might have a factory or a company that's growing, and you're putting money back into it. You're not taking it as income, and the business becomes more and more valuable. Or someone owns scrap metal. The more scrap metal he has, the more wealth he has."

Excerpt from How The Millionaire Next Door Got That Way Save. Don't spend. When you do have to spend, be frugal. Then someday you, too, could be a millionaire. Really! - August 17, 1998

Maybe stock mutual funds will provide the best return going forward. I don't know. But I did find it interesting when I started reading the various Stanley books and found out most people who were millionaires didn't have a a big percent of their assets in stock mutual funds. In one of the Stanley books he had some thought along the lines of most millionaires like to control their money, and they can't control the stock market. And when they do own stocks it is often closely held or individual publicly traded stocks.

[samclem]

Quote:

Originally Posted by daylatedollarshort I don't think studying existing millionaires provides all the answers on the best asset allocation for the future, but it does provide some food for thought and another data point to consider. I have found it interesting that in the Thomas Stanley research I've seen, most millionaires don't have a huge percent of assets invested in stock mutual funds -

Three problems I see:
1) If a person has a VERY big portfolio, they may choose to invest in individual stocks rather than MFs >even if they invest in the the identical securities< just to avoid the MF fees/expenses. That's unlikely to be the case for those with smaller portfolios: MFs and ETFs can be bought with less overhead than buying the stocks themselves unless the lots are very big.
2) There's not much reason to think "millionaires" make better investors, especially if that's not how they got their money.
3) Even if a person did make their millions by investing, that doesn't mean their methods are good ones. If 1000 people are each given $1000 to invest in stocks, the only ones who will have a million dollars in 10 years are those who made highly leveraged bets or those who invested in a highly concentrated way (in one or two speculative companies). 95 of 100 people who try that will go broke. But, if we surveyed the "millionaires" those are the techniques we'd see represented. Buying a broad index fund would likely have allowed an investor to "only" double his money in this time--but that's the better way for most people to accumulate (and keep) a retirement nest egg.
Thomas Stanley should interview the investors who got poor results, he might find that direct-stock ownership is the rage in that population, too.

[daylatedollarshort]

Quote:

Originally Posted by samclem Three problems I see: 1) If a person has a VERY big portfolio, they may choose to invest in individual stocks rather than MFs >even if they invest in the the identical securities< just to avoid the MF fees/expenses. That's unlikely to be the case for those with smaller portfolios: MFs and ETFs can be bought with less overhead than buying the stocks themselves unless the lots are very big. 2) There's not much reason to think "millionaires" make better investors, especially if that's not how they got their money. 3) Even if a person did make their millions by investing, that doesn't mean their methods are good ones. If 1000 people are each given $1000 to invest in stocks, the only ones who will have a million dollars in 10 years are those who made highly leveraged bets or those who invested in a highly concentrated way (in one or two speculative companies). 95 of 100 people who try that will go broke. But, if we surveyed the "millionaires" those are the techniques we'd see represented. Buying a broad index fund would likely have allowed an investor to "only" double his money in this time--but that's the better way for most people to accumulate (and keep) a retirement nest egg. Thomas Stanley should interview the investors who got poor results, he might find that direct-stock ownership is the rage in that population, too.

All good points to consider. However, I found it interesting to note the low percent of allocation to publicly traded stocks, and from the other article the lack of interest in mutual funds. Even if more loser investors were studied for comparison, it wouldn't increase the percent of stocks or stock mutual fund winners' asset allocations.

Certain posters here get picked on for not having much larger portfolio allocations to stock mutual funds, but it seems like from the Stanley data many wealthy people actually do not put most of their savings in stocks or stock mutual funds.

[clifp]

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Originally Posted by daylatedollarshort All good points to consider. However, I found it interesting to note the low percent of allocation to publicly traded stocks, and from the other article the lack of interest in mutual funds. Even if more loser investors were studied for comparison, it wouldn't increase the percent of stocks or stock mutual fund winners' asset allocations. Certain posters here get picked on for not having much larger portfolio allocations to stock mutual funds, but it seems like from the Stanley data many wealthy people actually do not put most of their savings in stocks or stock mutual funds.

I'll point out the article is 15 years old 1998 and the data was almost certainly collected before the big tech boom (and subsequent bust).

But here is the kicker.

Quote:

He's typically a male with a net worth of between $1 million and $5 million. He lives in a house valued at $278,000, which is not extravagant. He's self-employed or owns a business or is a partner in private business, maybe pest control or carpentry, plumbing, air conditioning, or contracting.

A relatively small number of forum members own or owned their own business. We do have a modest number of doctors and lawyer who had their own practice, but even some of those draw salaries. Unlike the typical "millionaire next door", forum members by an large were paid salaries. We LYBM, saved heavily and many of us invested (more successful than the average American), either in the market or in real estate.

[daylatedollarshort]

Quote:

Originally Posted by clifp I'll point out the article is 15 years old 1998 and the data was almost certainly collected before the big tech boom (and subsequent bust).

The article may be older but the IRS estate data is from 2007 - 2009. You can do with the data what you want. I don't claim to have any answers or any crystal ball.

But when I read about millionaires wanting investments they can control and individuals not being able to control the stock market, and saw various versions of the assets millionaires do hold vs what places like Fidelity and popular financial writers suggest as normal / optimal, it personally gave me a lot of food for thought.

[Gatordoc50]

Quote:

Originally Posted by brewer12345 So what else do you own? Real estate?

Yes, mostly real estate. Some residential and some commercial and some land. Our plan is to live off our rental income and stock/bond portfolio and sell property when/if necessary. For business owners with income above IRA limits, any money invested in retirement accounts is accompanied by employer contributions to employee accounts. So it represents more of an employee benefit than an investment. I doubt that very many folk would invest in the market if it wasn't incentivized by the government. It's the tax treatment that makes it a viable investment. Stocks as a stand alone investment offer too much risk for too little return, IMO. Some like stocks over real estate due to their liquidity but as Bernstein points out, liquidity is a deep risk in the hands of most investors.

[nun]

Quote:

Originally Posted by haha A few things jump out- this advice is not just more of the same asset 60:40 or 50:50 stock:bond asset allocation, and save 25X spending before retirement. This is a lot more demanding. He says that if you are not working, you should have 15-20 x your (expenses-(SS and pensions)) in liquid and ultra safe investments like T-bills and short term liquid notes and CDs. Now remember that these investments are designed to guard against shallow risks, which are relatively short term, but will leave one heavily exposed to deep risks which tend to be longer term, but may actually come suddenly. He more of less suggests that retired people must design to deal with shallow risks, no matter what other risks may be left unguarded. It seems that if this book is taken to heart, and if a secure retirement is something you want, run, don't walk to get a government job if you can. Otherwise save enough for your chosen SWR, but also save another 15 -20 x(expenses not covered by COLA annuities). So non-govt workers had better have very good jobs, or no life, or both, while they try to put together this huge amount of retirement funds.

The stock bond allocation and 4% SWR is a pretty recent dogma, surely. Before everyone in the US was funding retirement with defined contribution plans directly subject to the ups and downs of the economy people used annuities as the default. That's still the case in most other countries. To recommend 15 to 20 x (expenses - COLAed pensions) in cash and ultra safe fixed income is a big psychological shift.......and a good one IMHO. But it sounds like old news to me.

I plan to fund my entire spending from US and UK SS and a small company pension, so (expenses - COLAed pensions) = 0. When I was given the opportunity to pay into both US and UK SS I took it immediately as I figured it would be good to have the interest linked stable income sources. that was 27 years ago. So I've paid two sets of social security taxes for 27 years and I'll collect about $24k from the UK and the US at age 66. That $48k along with $20k rental income and $5k pension will cover my spending at age 66. Real estate equity and other retirement savings are a back stop.

[brewer12345]

Quote:

Originally Posted by Gatordoc50 Yes, mostly real estate. Some residential and some commercial and some land. Our plan is to live off our rental income and stock/bond portfolio and sell property when/if necessary. For business owners with income above IRA limits, any money invested in retirement accounts is accompanied by employer contributions to employee accounts. So it represents more of an employee benefit than an investment. I doubt that very many folk would invest in the market if it wasn't incentivized by the government. It's the tax treatment that makes it a viable investment. Stocks as a stand alone investment offer too much risk for too little return, IMO. Some like stocks over real estate due to their liquidity but as Bernstein points out, liquidity is a deep risk in the hands of most investors.

Seems to me that real estate is heavily driven by favorable tax treatment as well.

Different strokes. I think the liquidity driven risk is way overblown, but de gustibus non disputandam.