![]() Tragically, it's the investors who act in moments of panic to save their capital from perceived loss who are the ones most assuredly condemned to experience the ravages of deep risk. Stock market investors who overreact to drawdowns and sell at inopportune occasions are far more likely to miss out on the subsequent recovery rally than the ones who sit still through the crisis and do nothing. On the other hand, what triggers deep risk isn't the declines themselves - but ironically, investor behavior during those declines. While investors may understandably lose sleep over pullbacks, corrections, recessions, or once-in-a-generation declines, they all represent forms of shallow risk and are unlikely to have deleterious effects on terminal wealth - so long as one holds through the worst of it and refuses to sell. Deep risk: "a permanent loss of real capital".Shallow risk: "a loss of real capital that recovers relatively quickly, say within several years".Neurologist and investor William Bernstein endorses this view, arguing in his book Deep Risk that there are really two types of risk, at least in a qualitative sense: Munger may have been a bit harsh, but he's got a point: drawdowns, even the big ones, aren't anything to worry about. Charlie Munger, Warren Buffett's longtime investment partner and second-in-command at Berkshire Hathaway, puts it bluntly, noting that "if you're not willing to react with equanimity to a market price decline of 50% two or three times a century, you're not fit to be a common shareholder and you deserve the mediocre result you're going to get." Most drawdowns are just short-term noise However, even these seemingly disastrous crashes shouldn't faze investors. These significant financial crises have historically rocked markets just once every several decades. On the other hand, the most dramatic of drawdowns - declines of 50% or more - like those that occurred in the wake of the Global Financial Crisis of 2008, the 1970s recession, or during the Great Depression in the aftermath of the crash of 1929 - are far rarer.
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