The Permanent Portfolio
I’ll be reviewing several different fixed asset allocation portfolios in the next few months, pointing out their pros and cons. Each investor ought to develop his own asset allocation and stick with it, rebalancing to maintain appropriate risk levels. The first portfolio I’m going to review is called The Permanent Portfolio. This portfolio consists of the following asset classes:
- 25% Stocks
- 25% Long-term US Treasury Bonds
- 25% Gold
- 25% Cash
This portfolio was espoused by Harry Browne beginning with books he wrote in the seventies. Mr. Browne is a hero to hard-money advocates, goldbugs, survivalists, and Libertarians and in fact was the Libertarian candidate for president in 1996 and 2000. The theory behind the portfolio is that the economy is always in one of four states:
In each of these situations, at least one of the four asset classes should be performing very well. In times of prosperity, the stock market outperforms. In a bear market recession, long-bonds do well as investors flee stocks and interest rates come down. Gold is traditionally a hedge against inflation and devaluation of currencies and stocks also tend to do well with inflation. In times of severe depression, cash and bonds should outperform. The goal isn’t to get rich quickly, but to provide moderate returns throughout all types of economic environments.
There are many different ways to implement the portfolio and you can obviously individualize it to taste. For example, for the stock portion you could use an S&P 500 index fund or a total stock market fund. You could also use a growth stock fund, as theoretically they should do particularly well in prosperous times. Personally, if I were implementing the portfolio, I’d use either a one-stop inexpensive ETF/Fund such as Vanguard’s Total World Stock Index, or perhaps save a few basis points on the ER by splitting the stock portion between the US Total Stock Market Fund and the Total International Stock Market Fund. Harry Browne seemed to allow for either long-term treasuries or long-term corporates for the bond component. I’d use a low-cost long-term treasury ETF/Fund such as the Vanguard Long-Term Treasury Fund, but one could use zero-coupon bonds or even build your own ladder of treasuries at Treasury Direct. The gold component advocated by Mr. Browne was actually holding the physical metal. As discussed previously, you could also hold precious metals indirectly via a mining stock fund or a gold-holding fund/ETF such as GLD. The cash portion of the portfolio isn’t meant to be dollars stuffed in your mattress, but cash equivalents such as a money market fund, treasury bills, or a high-yield bank account, which would be my current choice given current yields. Harry Browne contributed to a Permanent Portfolio Mutual Fund (PRPFX), which tries to implement these theories. It was founded in 1982, has over $14 billion in assets, an expense ratio of 0.77%, and a long-term return of 6-7%. I don’t particularly recommend investing in that as you could build the component pieces using ETFs at less than 1/3 the cost, but it does make for a one-stop solution at a reasonable cost with a reasonable long-term record.
There are a number of things I like about the permanent portfolio. As a fixed asset allocation portfolio, I like that it doesn’t require the investor to predict the future. It requires little maintenance (rebalanced once a year) and nearly completely eliminates emotion and behavioral pitfalls from the picture, so long as the investor doesn’t get affected by the severe tracking error the portfolio will have when compared to more traditional portfolios. The portfolio has done quite well over the last decade when heavy stock portfolios have struggled, boasting returns of over 10% per year. The investor will always get to console himself that something in the portfolio is doing pretty well. I think this is a portfolio that a physician investor can use to reach his goals if he can stick with it through the years.
I don’t use the permanent portfolio for several reasons. First, I am at a stage in my life when I have a need, ability, and willingness to take on a great deal of investment risk. My current portfolio size/retirement portfolio size ratio is quite low, I have a high, steady income, and I have decades to go to retirement. The permanent portfolio is, by its very nature, quite conservative. It doesn’t have much in the way of risky stocks, and fully 1/2 of it is invested in fixed income. Gold is a volatile asset, but when balanced against stocks tends to reduce portfolio volatility. Second, I prefer having more of my portfolio invested in assets with a positive expected real return. Over the long-term, neither cash nor gold have traditionally provided significantly positive after-inflation returns. I need my portfolio to grow as I prefer NOT to have to save every dime I’m going to spend in retirement. Expecting just 1/2 of my portfolio to do all the heavy lifting of portfolio growth is a bit much to ask in my opinion. Although I have bonds and cash-like assets in my portfolio, they are far less than 50% of my portfolio. Third, as mentioned in other posts, I don’t think there is anything wrong with holding gold, but I think 25% is far too much of a portfolio to invest in a volatile commodity. Obviously, my portfolio would be better off the last 5 years if I’d had a different opinion, but you makes your bets and you takes your chances. Fourth, I don’t like running the interest rate risk inherent in long bonds. I feel like the sweet spot with bonds (best risk:reward ratios) is generally in the intermediate maturities. So putting 25% of my portfolio into long bonds is a bit extreme for my taste. Lastly, I’m a pretty stubborn guy, and I can stick with a portfolio that I believe has a sound theoretical basis for a long-time despite underperformance, but I don’t think I could stomach the tracking error a portfolio like the permanent portfolio would have against a stock-heavy portfolio in long periods of prosperity. I fear I would bail out of it at the wrong possible moment. I don’t think there would be any way I could hold a 25% gold portfolio for 25+ years beginning in 1982. I suspect there are few that could. Most people chase performance, either consciously or unconsciously, and most advocates of the permanent portfolio haven’t been using it for more than 10 years.
There are lots of ways you can implement the ideas in this portfolio without adopting it completely. You could designate a small percentage of your portfolio to precious metals. You could designate some of your bonds to be long-term bonds. You could hold a small cash allocation. But whatever you decide, the most important thing is to stay the course. Most reasonable portfolios will accomplish your goals if you can stick with them and not torpedo your plan at the worst possible moment by getting greedy or fearful. Determine a reasonable allocation, write it down, keep your costs low, rebalance periodically, and stay the course and you are highly likely to have investing success.