The Permanent Portfolio – What it is and How it Works

the permanent portfolioMarc recently wrote an article on The All Weather Portfolio, the investment strategy made famous by Ray Dalio.  While I like the concept behind the all weather portfolio, as Marc points out in his article, the strategy is difficult to replicate.  It also needs to be adjusted based on what the anticipated volatility of the asset classes you are investing in is going to be, an assumption that I don’t think most investors are qualified to make.

There is another option however that follows a similar line of thinking to the All Weather Portfolio, but in my opinion is much more straightforward to execute.  Its called the Permanent Portfolio.

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What is the Permanent Portfolio?

Like the All Weather Portfolio, the Permanent Portfolio invests based on the assumption that the future is not predictable, but should be defined by one or more of the below conditions:

  1. prosperity

  2. recession

  3. inflation

  4. deflation

With this in mind, you should aim to construct a portfolio which performs well in any of these conditions. The goal of the Permanent Portfolio is to provide “safety, stability, and simplicity”.   The theory was developed by Harry Browne who was the Libertarian party’s candidate for president in 1996 and 2001.  He wrote a book outlining the Permanent Portfolio called Fail Safe Investing.

 

Browne recommends dividing your portfolio up into 4 equal pieces:

  1. 25% in US Equities, which should perform well during times of prosperity and/or inflation.

  2. 25% in long term treasury bonds which should perform well during times of recession and/or deflation.

  3. 25% in cash equivalents which adds stability to the portfolio.

  4. 25% in gold to protect yourself against inflation.

 

Proponents of the permanent portfolio point towards its long term track record which shows that a portfolio constructed in the manner above would have returned around 9% per year on average.  More impressively however, it has only had 3 losing years, the worst of which was a -4.1% return.  As we have seen the US market fall by more than 40% twice in the last 10 years, that’s pretty darn good.

The Permanent Portfolio also lives up to its goal of simplicity because it is pretty straightforward to set this up.

Permanent portfolio skeptics have some points as well however.  Most of the arguments revolve around the time period used when evaluating the Permanent Portfolio’s historical returns.  Before 1971 the dollar was pegged to the price of gold, so there would have been no difference between the gold and cash portions of the portfolio.  Therefore you really cannot evaluate the portfolio before 1971.  Skeptics point to the fact that from 1972 to 2012 both gold and long term government bonds have had incredible runs, that are not likely to repeat in the future.

What do I think?

While past performance is not necessarily indicative of future returns it is encouraging that the Permanent Portfolio has performed well in many different types of market environments.   I like the simplicity of the Permanent Portfolio and think that investors could do a lot worse than following this methodology.

If I were setting the portfolio up for myself I would include more international equities and bonds as a much larger slice of global GDP and growth these days is coming from areas outside of the United States (your can read more about this here).  I am also not concerned about having such a high portion of the portfolio in gold.  While I don’t know what is going to happen to gold in the short term, it has been a reliable store of wealth for thousands of years, and I don’t see that changing in my lifetime at least.

 

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Comments

  1. technovelist says

    90% of investors would do better with such a portfolio. It is low-cost, tax efficient, and protects against almost any catastrophe short of a giant asteroid strike. And that’s pretty hard to hedge against…

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