Monday, August 15, 2011

Permanent Portfolio Investing

I learned about Harry Browne's "permanent portfolio" from Josh "Personal MBA" Kaufman's blog. If Harry's name sounds familiar, you might remember him as the Libertarian Party's presidential candidate in 1996 and 2000.

Browne wrote extensively about investment topics, starting with his first book, 1970's "How You Can Profit From The Coming Devaluation". In his 2001 book, "Fail-Safe Investing", Browne proposed his concept of a "permanent portfolio" for the money you can't afford to lose (as opposed to a "variable portfolio" for the money you can afford to lose). Browne's permanent portfolio splits its assets among four radically different and uncorrelated asset classes:

  • 25% Stocks
  • 25% Long-term Bonds
  • 25% Cash
  • 25% Gold

The goal is to produce capital appreciation with less market volatility, even during turbulent markets.

The permanent portfolio has gotten a lot more attention in recent years, thanks to the 2008 economic crisis and stock market crash. The portfolio's historical performance is strong; the CAGR from 1972 (when Bretton Woods ended and the US went off the gold standard) to 2008 was 9.7% (during that same period, the return on the S&P 500 was 9.3%). During the 2008 crisis, when the S&P 500 was down 37%, the permanent portfolio eked out a 2% positive return.

The permanent portfolio is not without controversy; there is an extremely lively discussion of the permanent portfolio over on the Bogleheads forums (Bogleheads are devotees of Jack Bogle, the founder of Vanguard, who evangelized low-cost investing). Bogleheads are extremely quantitatively-inclined, and their commentary is both well-researched and erudite; I strongly recommend perusing the forum for a wide range of views.

The main criticism of the permanent portfolio stems from its position in gold, which is a shiny metal that produces no dividends, and has minimal intrinsic value. "Gold bugs" tend to have a bad reputation in the financial services industry; the stereotypical gold bug is suspicious of the Federal government and also owns a mountain cabin that is plentifully stocked with firearms. It's also the case that the portfolio's returns have been helped by the meteoritic rise in gold prices over the past few years.

What is true is this: Since 1972, in a wide variety of markets including the gut-wrenching 70s recession, the early 80s and 90s malaise, as well as the dot com bust and the credit crunch, the permanent portfolio has only registered one annual loss--3.9% in 1981.

Josh Kaufman offers his suggestions for building a permanent portfolio using low-cost ETFs:

  • 25% Total Stock Market Index – via the Vanguard Total Stock Market ETF (Ticker: VTI)
  • 25% Long-Term Government Bonds – via the iShares Barclays 20+ Year US Treasury Bond ETF (Ticker: TLT)
  • 25% Gold – via Central Gold-Trust, which holds gold bullion (Ticker: GTU)
  • 25% Cash – via the iShares Lehman 1-3 Year US Treasury Bond ETF (Ticker: SHY)

You can also invest in the Permanent Portfolio Fund (PRPFX), a mutual fund that Harry Browne advised prior to his death. Its composition is different, but focuses on achieving the same goals. Here's a quick comparison of portfolio versus fund performance.

















































Year
PP
PRPFX
2000
3.2%
5.8%
2001
0.9%
3.8%
2002
7.0%
14.3%
2003
14.0%
20.4%
2004
6.6%
12.0%
2005
8.1%
7.6%
2006
11.0%
13.8%
2007 12.9% 12.4%
2008 1.9% -8.4%
2009 7.8% 19.1%
2010 14.5% 19.3%

Over the 11 year period, the fund outperformed 8 times, the portfolio 3 times.

Color me intrigued. This definitely bears further investigation.

1 comment:

John J. Walters said...

This is relevant to my interests.

Love the bit about the stereotypical gold bug. Sounds like somewhere I'm headed, but I'd trade the cabin for a boat.