Is The Permanent Portfolio... Foolish?

[Coffee]

I remember reading about the "Foolish Four" ... the Motley Fool's riff off the 'Dogs of the Dow' strategy.  They're not advocating it anymore, with the explanation:

"We responded to the critics by conducting the most extensive test that we know of on the historical performance of high yield/low price Dow strategies. This far more comprehensive backtest revealed that the high returns quoted by us and by others (Beating the Dow, the Dogs of the Dow, and certain mutual funds come to mind) was mostly ephemeral. When we looked farther back in time and at portfolios not run on a calendar year basis, most of the outperformance that had so excited us dissipated. We were left with an estimated outperformance of less than 2% per year, which sounds OK until you compare it with our original expectations or with the far more tax efficient index funds.


So... is there any possibility we may be looking at the PP through the same Foolish lens?

[Tortoise]

Past returns are never a guarantee of future returns, so I take them all with a grain of salt--including the average historical returns calculated for the PP.  Who knows what its return will be in the future?  Not me.  I just know that the PP tends to be significantly less volatile than traditional stock/bond portolios, that there are good common-sense reasons why this is so, and that for me, low volatility is of central importance in ensuring I stick to the plan rather than bail out when I see 50% of my portfolio go up in smoke.

There are many things I like about the PP, but the thing I like the most is the fact that its asset selections and allocations are rooted firmly in a sound economic model:  the theory that the economy goes through quasi-periodic cycles of prosperity, inflation, recession, and deflation due to the combined actions of governments and countless private individuals.  (Or if you lean towards economics of the Austrian school, as I do, then the theory is that most of the cycle swings are caused by government actions--particularly central banks.)  The economic model underlying the PP also acknowledges the inherent uncertainty of financial markets, which I appreciate.

Few, if any, asset allocation strategies I've come across are rooted in sound economic theory and a healthy dose of market agnosticism like the PP is.  Most of the other strategies rely almost exlusively on historical returns and/or require the ability to hang tight through gut-wrenching market swings of up to 50% or more.  I don't know what return the PP will provide in the years to come, nor do I really care.  I just sleep easy knowing I won't get completely clobbered by the next global economic tsunami--whatever it turns out to be.  That's an asset allocation I know I have the intestinal fortitude to stick with long-term.

[Coffee]

You don't care what return your investment will provide in years to come?

[Snowman9000]

I think it depends on your expectations.  A person wanting the best performing portfolio during their investing lifetime will probably eventually regret the PP.  It's unlikely to be the best going forward.  Well, it could be the best, but probably not.  If only we knew what will be the best!  Over the past few years, I have become distrustful and disrespectful of backtesting.  It's a false hope.

It is important to understand the "goals" of the PP design.  You've seen the description "growth & income" applied to mutual funds?  The PP is growth & protection.  It is designed to be sturdy, and all-weather.  Tortoise and the hare, and all that.

Don't underestimate the comfort or sleep factor either.  The hare portfolios are harder to stick with because when they go bad, they really go bad.  As Bill Bernstein wrote, it's one thing to practice a crash landing in an airplane simulator, another to do it live.  Everyone thinks they will stick to the investing plan in bad times.  With the PP, the danger of bailing out is not so much the bad times being too bad, but the good times not being good enough by comparison to whatever is winning the race.  Many current PP advocates will bail when we have a long bull market in stocks.  Oh well.

Personally I think a young investor needs to experience the good, the bad, and the ugly first hand.  Having done that, my appreciation of the PP is much greater.

[craigr]

I remember reading about the "Foolish Four" ... the Motley Fool's riff off the 'Dogs of the Dow' strategy.  They're not advocating it anymore, with the explanation:

"We responded to the critics by conducting the most extensive test that we know of on the historical performance of high yield/low price Dow strategies. This far more comprehensive backtest revealed that the high returns quoted by us and by others (Beating the Dow, the Dogs of the Dow, and certain mutual funds come to mind) was mostly ephemeral. When we looked farther back in time and at portfolios not run on a calendar year basis, most of the outperformance that had so excited us dissipated. We were left with an estimated outperformance of less than 2% per year, which sounds OK until you compare it with our original expectations or with the far more tax efficient index funds.

Several years into my serious investing days I came across the Motley Fool. The main problem with their approach is they advocate indexing, but mix in a lot of market timing advice. The indexing advice is great, the market timing advice is not. The Foolish Four Strategy (I had some money in it before I knew better), was a pure backtested approach. Meaning that they thought the past returns would continue forward as they did in the backtest. This of course was wrong.

The Permanent Portfolio creators used backtesting to prove and disprove their economic ideas on the assets they wanted to use. They weren't necessarily going for the biggest backtested returns. Good diversification gave them good returns but as you know nobody can guarantee this. They just thought that the wide diversification based on economic cycles would be superior to market problems and over time be able to prosper no matter what was going on. This information is direct from John Chandler who was Harry Browne's publisher and co-founder of the Permanent Portfolio Fund. They saw that the mix of assets they wanted to use were very resilient to market problems. This analysis helped focus the development.

Not just this, but the portfolio is not relying on market timing or indicators on when to sell. This is opposed to the Foolish Four which was tracking dividend yields monthly if I recall? It had you moving in and out of stocks in the Dow at a pretty regular basis and had you holding no diversifying assets like bonds, cash or gold. Note also that this strategy is a classic example of chasing yield which is also very dangerous because companies paying higher yields can sometimes be doing so because they are weak. When market problems come around that weakness shows up with faster falling stock prices.

I readily admit that some people following the Permanent Portfolio strategy are probably performance chasing (this happens with all Morningstar highest rated funds). But this happens all the time. However not everyone is doing this and for those people the approach works. Up to this point the strategy has been able to produce decent returns with low volatility. If the stock market ever gets really humming again (although it's actually doing well the past two years in raw numbers) then the  popularity of the approach may fade. But that doesn't mean the strategy has failed. It's just not designed for dragster like performance in hot markets which is what performance chasers want.

[Coffee]

Always a thoughtful reply.  Thanks.

I don't remember it being rebalanced monthly, though.  I thought it was once a year, but I could be wrong?

[Tortoise]

You don't care what return your investment will provide in years to come?

Okay, maybe I care a little bit

[Coffee]

You don't care what return your investment will provide in years to come?

Okay, maybe I care a little bit

I knew it. 
You love me.  You really love me.