"Half the portfolio has zero expected real return"

[KevinW]

One issue that's holding me back from embracing the Permanent Portfolio completely is my view that both the cash and gold allocations should have an expected yield of 0% over inflation in the long term.  Each is intended to be a store of wealth, rather than a purchase of a productive asset.  Common sense says that only the productive assets, stocks and bonds, would provide any real return in the long run.  However my instinct is that nearly all of my assets should be "working" for me.

Have more experienced Permanent Portfolio investors developed a way of coming to terms with this?  Is it something you just accept as a cost of safety?  Do you have reason to believe that the "rebalancing bonus" produces real returns?  Or is it something else?

[craigr]

I think the cash and gold provide protection when stocks and bonds are not able to. This protection can add gains to the portfolio. Although I agree with you in theory that gold and cash should have essentially zero real return, every time I've looked into the issue I've come to find out that cash and gold in fact do not hurt the returns compared to heavier stock and bond allocations and greatly reduce volatility. In fact, sometimes when the markets are doing crazy things it's the growth assets like stocks or bonds that get hit the hardest and cash and gold can be the only two things providing growth.

Another way to look at this argument is that stocks have the highest expected return of every asset in the portfolio. Yet over the last 10 years they have been perhaps the worst performer. They may in fact be worse than cash sitting in a money market fund the entire time.

So sometimes what we expect to happen, and what actually happen, are two different things.

When I first started the portfolio several years back I was very nervous about holding gold, LT bonds and so much in cash. I was a "Stocks for the Long Run" kind of guy. Well as it turns out it was the LT bonds and gold that kept the portfolio going when stocks really suffered. My prior stock heavy allocation had severe exposure to market risks. I find that I sleep much more soundly now having the balanced portfolio and do not mind the cash and gold allocation in the slightest.


EDIT: Keep in mind that the Permanent Portfolio can be used as the core holding and your variable portfolio can be used to overweight stocks and bonds if you feel like taking the risk. There is nothing set in stone that says you have to run a 100% permanent portfolio. You can use what you feel comfortable using. The idea is that the Permanent Portfolio can hold the money that is so important to you that you don't want to take big risks with it. But if you feel that you're not taking enough risks on stocks there is nothing to say you can't have 50% of your money in the Permanent Portfolio and 50% in a variable portfolio that just holds a bunch of index funds.

[pplooker]

I look at it a little differently.  Many investment strategies use short term bonds or TIPS, sometimes exclusively, and yet these are very low yielding instruments.  As I argued in another thread, the cash portion really isn't any different than holding short term bonds because consider what people use for it:

- Treasury Money Markets in a strict Permanent Portfolio
- I bonds in a more liberal one
- Certificates of Deposit
- SHY

All of these things generally do produce real returns, especially CPI indexed I bonds.  They're just very small ones.  I argue that the "cash" portion is really just whatever the investor perceives to be credit risk free highly liquid short term bonds.

Now gold... I will upset some people here but I actually will argue that gold does not produce real returns, but rather its price just swings wildly sometimes in response to the insanity of crowds.  The only reason gold is part of the strategy is because its price doesn't move in lock step, at least not as much, with the other things in the portfolio.  It truly does have no inherent objective value beyond a few industrial applications.  However, it doesn't matter.  All forms of money are simply a common fiction and enough people have embraced the fiction that gold is money, that it has become money.  This is extremely unlikely to ever change.  It's as close to a universal, timeless human currency as we are ever going to see.  Buying a big fat slice of gold is an elegant way to protect yourself against fluctuations in fiat money.

If you want to be cynical about it, you could argue you're just taking advantage of idiots who buy shiny rocks.  I merely shrug and realize there's a market for the stuff, so why not take advantage of it.

The people who say gold is inherently worthless are actually 100% right, but it doesn't matter that they're right so long as the fiction persists.  With that said, the gold is a key part of the permanent portfolio concept because the point is that you don't get wild up and down swings like you do with other strategies.  Some strategies, like my VP, are built around the assumption that the value of the portfolio may swing from zero to infinity at any given moment in time, it's just there's some mechanism in place that the investor believes will make it come out to his ultimate advantage in the desired time frame.  The permanent portfolio rejects that notion that your wealth should do that.

[Pkg Man]

I will upset some people here but I actually will argue that gold does not produce real returns, but rather its price just swings wildly sometimes in response to the insanity of crowds

I am not easily offended, so this certainly doesn't upset me, but I think you are incorrect.  If what you say is true then the price of gold should only fluctuate around one price and never drift upward except for inflation.  However, given an increase in population I would expect gold to grow by some real positive amount over time.  But I just got back from a happy hour, so my thinking could be clouded. 

[KevinW]

I think the cash and gold provide protection when stocks and bonds are not able to. This protection can add gains to the portfolio.

I guess I can relate to the idea of allocating some resources to protection instead of production.  In the business world I see that companies have a lot of resources dedicated to production, but they also spend a lot on protection -- real estate, security, patent lawyers, trademarks, etc.

Your advice that I could allocate more to productive assets through a big Variable Portfolio is well taken.

The people who say gold is inherently worthless are actually 100% right, but it doesn't matter that they're right so long as the fiction persists.

This is pretty much how I feel.  I think you could say the same thing about any currency and nearly all consumer goods.

However, given an increase in population I would expect gold to grow by some real positive amount over time.

I agree that population growth tends to increase demand for gold over time, but gold can also be mined or recycled to increase supply.

Yes the rebalance bonus does produce real returns, typically around 1.5% p.a, of the total fund value on average - which is similar to saying that both cash and gold each earned 3% real rewards.

Interesting.  I'm curious about how you arrived at the 1.5% figure.

Thanks for all the replies, they've given me a lot to mull over.