by Jason Jenkins, Investment U Research
Monday, March 26, 2012
I guess when you’re an investor or in the business it’s your mission to find vehicles, processes and theories that beat the market. This isn’t just a returns driven game but you must understand what you’re getting into in regards to your personal make-up and the market climate.
Talking to an old work buddy I was reminded of time long ago in a galaxy far away when money market accounts at your local mutual fund company gave you 4.5% return. Now, when monthly inflation squashes Treasury yields, what do you do for safety?
Here’s one option.
The Permanent Portfolio
If you pick up Harry Browne’s Fail-Safe Investing: Lifelong Financial Security in 30 Minutes, you’ll be introduced to his Permanent Portfolio. The libertarian/financial writer/presidential candidate’s theory has been out there for about 30 years and seems to be standing the test of time.
Browne divides investment money into two categories:
- Money you cannot afford to lose.
- Money you can afford to lose.
For that money you can’t lose, Browne recommends investing in a “permanent portfolio” that provides three key features: safety, stability, and simplicity. He argues that your permanent portfolio should protect you against all economic possibilities in the future, provide a steady performance, and be simple to put in play.
What makes up the Permanent Portfolio?
How do you not lose money? Harry Browne feels you need to select various investment components in a manner where one of the asset classes is favored in any economic climate. Here is the make-up. Each class should hold an equal proportion for as long as you’re in it:
- 25% in U.S. stocks, to provide a strong return during times of prosperity. For this portion of the portfolio, Browne recommends a basic S&P 500 index fund
- 25% in long-term U.S. Treasury bonds, which do well during prosperity and during deflation (but which do poorly during other economic cycles).
- 25% in cash in order to hedge against periods of contraction or recession. A money market fund.
- 25% in precious metals (gold, specifically) in order to provide protection during periods of inflation. Browne recommends gold bullion coins.
Once each year, you rebalance the portfolio. If any part of the portfolio has dropped to less than 15% or grown to over 35% of the total, then you reset all four segments to 25%.
Because this asset allocation is diversified, the entire portfolio performs well under most circumstances. Browne writes:
The portfolio’s safety is assured by the contrasting qualities of the four investments — which ensure that any event that damages one investment should be good for one or more of the others. And no investment, even at its worst, can devastate the portfolio — no matter what surprises lurk around the corner — because no investment has more than 25% of your capital.
Keep in Mind…
This is that old active versus passive investing prerogative. It’s a passive strategy built on diversification. It doesn’t use market timing.
It’s a defensive investment strategy that also happens to produce a decent return. But remember, its goal is stability.
The Permanent Portfolio strategy’s returns have a low correlation with the returns of the stock market (a correlation coefficient of 0.58), meaning that if you’re in it, you only reap the benefits of market gains about 50% of the time.
It has also enjoyed better than average returns over the past 10 years because of its high allocation in precious metals. As interest rates rise, the appreciation in precious metals will likely stall. Meaning a more equity-heavy passive portfolio, such as Alexander Green’s Gone Fishin’ Portfolio is likely to offer better growth going forward.