What is long term?
Bernstein means 30 years or more, a very long time but still well within an investor's lifetime horizon, even a retirement horizon nowadays.
What does he define as risk?
It's not a statistical measure like standard deviation; rather, it's an intuitive yardstick focused on the downside, permanent loss of capital, meaning a negative real after-inflation returns after 30 years. Shallow risk happens when the loss is recovered within a few years, such as the 2008 equity market crash. That's what volatility is and where it fits into the risk picture - a short term drop that is quickly recovered. Deep risk is when there is permanent loss. Finally, the measure of risk includes its magnitude - a small though though permanent loss doesn't matter much. It's losses big enough to be devastating to the investor that matter.
The devastating long term Deep risks and the effect on major asset classes
1) Inflation = Hyper/High 8+% price rises sustained for many years. Low steady inflation such as we have been experiencing in Canada for the past 15+ years, doesn't hurt any of the major asset classes.
- Losers: long term bonds, T-Bills
- Winners: equities, especially commodity producers, real return bonds
- Losers: equities
- Winners: long term bonds, T-Bills, gold gold (now that's a surprise since the popular image is that gold protects against inflation but he cites data showing that it counters inflation poorly; author and financial analyst James Montier comes to same conclusion in No Silver Bullets in Investing; gold is portrayed as worthwhile insurance for times when investors have lost faith in the government, which is more typical of severe economic depressions)
- Losers: potentially anything can taken, when governments are desperate, nothing is sacred
- Winners: foreign-held assets that your own government cannot grab, such as property; alternatively, leaving for another country that will not confiscate assets can work but it's a drastic measure
- Losers: no assets are safe
- Winners: foreign assets if the conflict is localized
Bernstein's parting words are simple and direct: "This booklet's primary advice regarding risky assets is loud and clear: your best long term defense against deep risk is a globally value-tilted diversified equity portfolio, perhaps spiced up with a small amount of precious metals equity and natural resources producers, TIPS [which are the US version of real return bonds], and if to your taste, bullion and foreign real estate." It's interesting that the TSX Composite index is already quite "spiced up" with a heavy weighting in precious metals and resources producers (11+%, vs only about 3% in the US total equity market), so investors with a broad Canadian equity holding like iShares S&P/TSX Capped Composite Index Fund (TSX symbol: XIC) have that part accomplished naturally. Another reason to count ourselves lucky!
The cautious investor has two main action takeaways from a look at long term risks:
i) Match investment assets and spending liabilities - control risk by matching a) near term spending plans with assets that can easily be cashed and are not subject to volatility, which is the main short term risk (e.g. T-Bills, GICs, money market funds, short duration bonds) and b) longer term spending, like a distant retirement, with assets that cope well with the biggest (impact x probability) long term risk - equities.
ii) Diversify - since most people have multiple investment goals and therefore spending horizons, it makes sense to keep some of the several types of assets.
Merry Christmas to readers!
Disclaimer: This post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.