What causes the Permanent Portfolio to go down?

[Indices]

If we look at the annual returns since the PP's inception, it's had negative returns twice. I believe both times were caused when the Fed raised interest rates dramatically to stem inflation, but I may be wrong. Is there a scenario where we could see the PP fall drastically or have several years of negative returns? I can't think of any, but perhaps others could.

[Roy]

Providing you are investing for the mid to longer term the periodic individual down years are just a characteristic of PP that has to be endured in anticipation of more likely being rewarded with real gains both relatively consistently and over the longer term.

Nice overview, Clive.

3 of the 4 PP asset classes are considered "safe havens".  Yet, it has achieved returns similar to portfolios that have much higher Beta exposures and greater risks.  The safe havens have, so far, protected it from the massive losses incurred by conventional portfolios (thus the competitive returns), though it has steady after-inflation returns.  Amazing work for a holding with just 25% equity exposure.

As Clive mentions, the PP has always ended the year in good order, even as it has had some rough intra-year patches;  this is likely just by chance.  2008 is a good example where the LT Treasuries boosted it in the last quarter, though it could have waited another quarter and the 2008 returns been worse (though the losses tolerable).  But those who scrutinize their portfolio will feel all its movements—in real time—not just the end-year response.  Something to consider from an emotional viewpoint.

Roy 

[Pkg Man]

I looked at the daily returns to the permanent portfolio components over the last few years to get some additional insight into how the assets move together.  While this approach may be flawed, from about mid 2005 to today the PP components all moved down on the same day 6% of the time.  In contrast they all moved up 12% of the time.  I used SHY for cash, S&P500 for stocks, IAU for gold, and TLT for bonds.

[simata]

I looked at the daily returns to the permanent portfolio components over the last few years to get some additional insight into how the assets move together.  While this approach may be flawed, from about mid 2005 to today the PP components all moved down on the same day 6% of the time.  In contrast they all moved up 12% of the time.  I used SHY for cash, S&P500 for stocks, IAU for gold, and TLT for bonds.

Looking to the daily numbers of PP, what was worst DD (peak to walley)?

[Pkg Man]

If by the worst day you mean the daily return calculated as the closing price on day t / closing price on day t-1:

          TLT         IAU         VTI         SHY          PP
min -3.2%       -8.5%       -9.4%     -0.7%     -3.0%

Source is Yahoo Finance from 1/28/05-5/14/10.

Note that the PP return is calculated as being perfectly balanced at all times, i.e., the PP daily return is simply .25 times each component's return. The worst daily return as shown above was -3%.  This is not the weighted average of the worst daily returns for each component, but the worst return on that particular day for the PP as a whole.

I hope that made sense.

[rickb]

I think Simata is asking about the worst total draw down, from a daily high to a subsequent daily low (not just in a single day).  Perhaps this would be a peak in 2008 to some subsequent low.  For comparison the S&P index dropped about 55% from its peak on about 10 Oct 2008 to its subsequent low on about 4 March 2009, and the DJIA dropped 89% from its high in 1929 to its subsequent low in 1932.

[simata]

I think Simata is asking about the worst total draw down, from a daily high to a subsequent daily low (not just in a single day).  Perhaps this would be a peak in 2008 to some subsequent low.  For comparison the S&P index dropped about 55% from its peak on about 10 Oct 2008 to its subsequent low on about 4 March 2009, and the DJIA dropped 89% from its high in 1929 to its subsequent low in 1932.

Yes this is what I'm asking with rebalancing only at the end of the year.

[Pkg Man]

OK, a lot of numbers but here goes:

The worst peak to trough drop using the daily data that I have (and likely the worst ever, but I can't prove it) was -14.5%.  The value of a hypothetical $1000 invested in the PP on 28 Jan 05 (earliest date of one of the index funds used) was $1439 as of 17 Mar 08.  The low point was reached on 12 Nov 08, at $1230.

The portfolio was rebalanced when the 15% or 35% bands were broken, even if only slightly. As I understand it, this is what the owner's manual recommends.  I think, but someone can correct me if I am wrong, that the annual reference is more of a check and that you don't need to rebalance if all assets are within their bands.

While 14.5% decline in less than one year is sizable, it pales in comparison to the 47% peak to trough drop in the stock market during that year.  And for all of 2008 the portfolio actually ended up 1.5% (at least the way I figured it, using 28 Jan 05 as my starting point and 15-35 rebalancing).  Treasury Bonds, gold, and stocks all showed significant growth at the end of the year, with average growth of about 18% following a rebalancing on 20 Nov 08.  The stock market fell 37% in 2008 from the end of '07 to end of '08.

I used VTI, IAU, TLT, and SHY from Yahoo Finance for computations.  I'd welcome someone double check my math and post their results.

[julian]

I ran those numbers today & the max drawdown in 08 was 10%.

[craigr]

I ran those numbers today & the max drawdown in 08 was 10%.

I seem to remember in 2008 that my portfolio was down around 10-12% at the worst point. Then the LT bonds went up sharply in price erasing all the losses.

Patience is an investor's friend.

Re: Can the portfolio drop in price?

Anything can happen. There is no guarantee with any investment strategy that money cannot be lost. But you just have to do your best. The Permanent Portfolio holds four very distinct asset classes that generally have few overlapping risks so I personally feel the portfolio is safer than other allocations I've seen. But there is always a chance we could get a serious blow that may result in losses. As to what scenario? We just don't know. What people think will happen rarely does and what nobody expects to happen is often the norm.

But on the positive note, a situation that would cause serious harm to the portfolio is likely going to be devastating to other allocations. IMO. So I don't know what could happen that would seriously hurt the portfolio, but I suspect for the market in general it would be much worse.

However I go back to 2008 as an example to being patient and let the economic forces working in the market to settle out. I remember during the height of the crash John Chandler was still on the air doing Harry Browne's old Money Talk radio show. He was getting people contacting him worrying about the portfolio because it was down 10% or whatever. He advised, and I totally agree, to just be patient. He pointed out that the portfolio had been beaten up in a variety of markets and each time it righted itself and kept on gaining in value. He was right. The lower relative volatility to other portfolio strategies allows investors to remain invested and be patient while the markets find their footing.

[stylo]

Re: Can the portfolio drop in price?

Anything can happen. There is no guarantee with any investment strategy that money cannot be lost. But you just have to do your best. The Permanent Portfolio holds four very distinct asset classes that generally have few overlapping risks so I personally feel the portfolio is safer than other allocations I've seen. But there is always a chance we could get a serious blow that may result in losses. As to what scenario? We just don't know. What people think will happen rarely does and what nobody expects to happen is often the norm.

But on the positive note, a situation that would cause serious harm to the portfolio is likely going to be devastating to other allocations. IMO. So I don't know what could happen that would seriously hurt the portfolio, but I suspect for the market in general it would be much worse.

However I go back to 2008 as an example to being patient and let the economic forces working in the market to settle out. I remember during the height of the crash John Chandler was still on the air doing Harry Browne's old Money Talk radio show. He was getting people contacting him worrying about the portfolio because it was down 10% or whatever. He advised, and I totally agree, to just be patient. He pointed out that the portfolio had been beaten up in a variety of markets and each time it righted itself and kept on gaining in value. He was right. The lower relative volatility to other portfolio strategies allows investors to remain invested and be patient while the markets find their footing.

The same 'wait-it-out' advice can be said of most portfolios, no? Just wait a bit longer with some. 

The PP does seem to come across as a perpetual motion machine, no? It does seem odd that the backtesting shows almost no periods with losses. You would think it either made no gains overall or at least some economic phases would tend to sink the entire ocean and all boats. Surely it goes up more in a bull market than otherwise, indicating a recession and cash is the weakest side at least?

Craig, you seem a very level-headed skeptic about this all, so can I ask what you, being intimately versed in the subject, see as the shortcomings or weakest side of the PP beyond simply a restrained upside? What are the devil's arguments out there against the PP?

I ask because I am about to start with the PP and - while I don't mean to make this a point about timing per se - if we assume a 2nd huge recessionary dip is coming, perhaps it is like buying into any other lazy portfolio when the market is high: you will still see gains, but not for ages. Or there is no high side to the PP and it is like a perpetual motion machine, which of course seems quite dubious.

Btw, Craig, thanks for all your obvious work in hosting and posting info for others. Appreciated.

[6 Iron]

Craig, you seem a very level-headed skeptic about this all, so can I ask what you, being intimately versed in the subject, see as the shortcomings or weakest side of the PP beyond simply a restrained upside? What are the devil's arguments out there against the PP?

stylo~, I believe the greatest risk for investing in the permanent portfolio is performance dramatically lagging the equity market in a prolonged period of prosperity, and pulling out (or modifying the percentages) at what turns out to be the worst possible time.

I found this to be an enlightening discussion on the Morningstar forum, with Craig joining later. Worth perusing the entire thing.  There is a well argued perspective from market timers why they would not consider the permanent portfolio, and (in my opinion), more substantive arguments from Craig. Hope it helps with your decision. Starting was the hardest part for me, but Harry Browne in his 16/17 rules maintains that you should never invest in something you do not understand or have confidence in. That applies to the permanent portfolio as well. Good luck.

http://socialize.morningstar.com/NewSoc ... 1274548301

[stylo]

Hey, I'm still only on p.55 at bogleheads... 

Thanks for the link.

I'm now in the stage of thinking it might be a high-point to buy in but leaning to DCA in; waivering on a low-point is not really an issue to me, as I'd use money outside of the PP.

Would be nice if we had data going all the way back to the 20s. I simply don't believe the PP or anything can make real returns without real risk.

[6 Iron]

Hey, I'm still only on p.55 at bogleheads... 

Thanks for the link.

I'm now in the stage of thinking it might be a high-point to buy in but leaning to DCA in; waivering on a low-point is not really an issue to me, as I'd use money outside of the PP.

Would be nice if we had data going all the way back to the 20s. I simply don't believe the PP or anything can make real returns without real risk.

While sifting through 6 more pages of posts is unappealing, I really appreciated the interchange. Still, you get through what you can. Emotionally, and practically, I DCA'ed in. It hurt with gold, and helped with long term bonds, and already owned equities (your mileage will vary). Made little difference at the end of the game, but was easier on the soul, and there is value in that.

I do not think anyone here would tell you that investing in a permanent portfolio does not carry real risk. It is a matter of comparison with other options, picking what best suits your needs, temperament and risk tolerance.

[craigr]

Re: Can the portfolio drop in price?

Anything can happen. There is no guarantee with any investment strategy that money cannot be lost. But you just have to do your best. The Permanent Portfolio holds four very distinct asset classes that generally have few overlapping risks so I personally feel the portfolio is safer than other allocations I've seen. But there is always a chance we could get a serious blow that may result in losses. As to what scenario? We just don't know. What people think will happen rarely does and what nobody expects to happen is often the norm.

But on the positive note, a situation that would cause serious harm to the portfolio is likely going to be devastating to other allocations. IMO. So I don't know what could happen that would seriously hurt the portfolio, but I suspect for the market in general it would be much worse.

However I go back to 2008 as an example to being patient and let the economic forces working in the market to settle out. I remember during the height of the crash John Chandler was still on the air doing Harry Browne's old Money Talk radio show. He was getting people contacting him worrying about the portfolio because it was down 10% or whatever. He advised, and I totally agree, to just be patient. He pointed out that the portfolio had been beaten up in a variety of markets and each time it righted itself and kept on gaining in value. He was right. The lower relative volatility to other portfolio strategies allows investors to remain invested and be patient while the markets find their footing.

The same 'wait-it-out' advice can be said of most portfolios, no? Just wait a bit longer with some. 

Yes this is true. But some portfolios you have to wait much longer than others.

Craig, you seem a very level-headed skeptic about this all, so can I ask what you, being intimately versed in the subject, see as the shortcomings or weakest side of the PP beyond simply a restrained upside? What are the devil's arguments out there against the PP?

The biggest problem I see in the portfolio is if we hit a really solid stock bull market that the portfolio could lag the market so much that people want to abandon it. There is an argument that could be made, maybe, that it holds too little in stocks which traditionally have been a powerful growth asset. But then again history has also shown some pretty long pockets of dead air waiting for stocks to deliver.

So the devil's argument from my perspective is maybe it could hold too much in gold and/or cash and maybe too little in stocks. But to counter this I would add that so far it's worked pretty well as is. But I still can't shake my pro-stock programming completely. This is usually why when people ask about changing around assets in the portfolio (like using REITs, or some other other fund du jour) I simply advise them to just hold more stock exposure in their variable portfolio. The reason for this is if the bet pays off it can really boost performance, but if it craters you still have the other three assets (bonds, cash and gold) to buffer the losses.

I ask because I am about to start with the PP and - while I don't mean to make this a point about timing per se - if we assume a 2nd huge recessionary dip is coming, perhaps it is like buying into any other lazy portfolio when the market is high: you will still see gains, but not for ages. Or there is no high side to the PP and it is like a perpetual motion machine, which of course seems quite dubious.

You know I always read every year about some new bull market in this and bear market in that. I just ignore them. We could get some 2nd recession as you point out but maybe it won't work out the way you think. Maybe it will be bonds that get hit the worst. Maybe it will be gold. I see people all the time calling for a gold market crash. Same thing for a bond market crash. So for them a recession means those assets getting pummeled and not stocks.

For me, I think the Permanent Portfolio makes you safer because of the wide diversification across many assets. If you are concentrating your wealth you take on higher risks if that just happens to be the asset to get hit next. So I would suggest that by not diversifying you may in fact be exposing yourself more to a second recession than someone that did diversify ahead of time.

Btw, Craig, thanks for all your obvious work in hosting and posting info for others. Appreciated.

No problem. Harry Browne and others helped me so I'm just passing it along...

[craigr]

Hey, I'm still only on p.55 at bogleheads...  ;D

Thanks for the link.

I'm now in the stage of thinking it might be a high-point to buy in but leaning to DCA in; waivering on a low-point is not really an issue to me, as I'd use money outside of the PP.

Would be nice if we had data going all the way back to the 20s. I simply don't believe the PP or anything can make real returns without real risk.

There is risk in any investment. I hope I don't give the impression that the Permanent Portfolio is riskless because it isn't. It's main feature that I like is that it attempts to balance risks off against against each other by the assets it holds. Risks can show up and they could impact the portfolio. But so far those risks have been washed out by another asset that buoys the portfolio. There is always a chance the portfolio could lose money. But, as I tell people, you just try your best to do what you can to protect yourself. While I personally think the Permanent Portfolio approach is a good way to accomplish this, ultimately the decision is up to the individual that is putting their money at risk.

I'm not saying this because I don't have confidence in the strategy. It is however a market reality that surprises happen all the time and something could happen to affect the Permanent Portfolio assets all at once. I don't know what condition that would be, but it could happen I suppose. The only thing I can add, as I stated earlier, is something that drastic to hurt the portfolio across all the assets at the same time would probably be devastating to a standard stock/bond portfolio.

But realistically anything that hurt the assets all at once I think would probably be short-lived and one or more of the assets would probably rebound strongly to counter the losses. IMO.

[stylo]

Thanks.

As someone just beginning to educate himself on portfolios, let me play devil's advocate for a moment as best I can. Please critique me.

My main concern is that the gains from the risk in the PP have been dangerously obfuscated in favor of magical portfolioism.

The PP is sold as something that can handle anything, like a perpetual motion machine. Set it and forget it and it will simply make a bit of money. That is nonsense. When people say that they are relaxed because they have a PP - not a pee-pee - and don't have to worry about the market, they have deceived themselves. Its gains came from risk as with every other portfolio. If everything truly canceled out, it would net 0 less expenses. It gained from the overall risk of owning gold/bonds/stocks over a particular period. It was, in essence, overall a good value buy for that period.

However, if you think it intelligent to state that gold/bonds/stocks now have historically little upside, then it follows that the future returns from the risks inherent in the PP will NOT resemble the past at all, rather the opposite. Is it truly just a totally random guess to say those 3 PP categories will trend poorly over the next 5 years or so even if we can't predict what will happen along the way? If my sports team has won for many years I'm going to keep betting on that; if however I see all the best players are now old and injured I am foolish not to re-evaluate and bet on who I think can win going forward. Or maybe you think things will continue to trend well?

Replying that we don't know about highs and can't know what will happen next but, in any case, the PP has churned out a gain in the past, is simply ignoring the point being made: what exact risk did that gain come from in the past? Or if we reply, "Well, it won't necessarily make a gain, every portfolio is a risk!", we finally acknowledge that the system is based on the risk of owning those particular assets, not a magic formula that simply works out.

So: that risk needs to be clearly focussed upon and outlined, not the magic formula, then evaluated against the current situation and our ideas about the future.

There's no getting around that with fancy word-play or pleas of ignorance. If you try to do so while advocating the PP, you're really just hiding behind a "perpetual motion" theory of how the PP works: Put the money in, lock the door, presto-chango, you made 9%! Don't ask me what happened!

Well, I want to know exactly why it happened, then think whether it will happen some more, and compare that to other portfolios.

In general, I think a couple things hurt the valuable discussion here:

1) the data using gold from around 72 should not even be listed, it is highly irregular and misleading. Scrub it and all discussion of returns based upon it, make it a footnote, and only use figures starting later. (Can someone remind me the PP gains from, say, 81 to present?)

2) the entire "we-can't-rely-on-the-past-or-know-what-will-happen" line is largely disingenuous. Certainly we hedge to limit losses and the PP does that well, but the only reason to buy the PP is because of past performance and reasoning that it will continue. That's exactly how we compare portfolios. Why not buy TSM or pokemon collectibles if we truly can never know what will happen? Well, because we are making judgements about the present and future and using the past to help us do so. 

OK, survival of the fittest. Please show me how that reasoning is horribly wrong. 

[MCSquared]

Thanks.

As someone just beginning to educate himself on portfolios, let me play devil's advocate for a moment as best I can. Please critique me.

My main concern is that the gains from the risk in the PP have been dangerously obfuscated in favor of magical portfolioism.

The PP is sold as something that can handle anything, like a perpetual motion machine. Set it and forget it and it will simply make a bit of money. That is nonsense. When people say that they are relaxed because they have a PP - not a pee-pee - and don't have to worry about the market, they have deceived themselves. Its gains came from risk as with every other portfolio. If everything truly canceled out, it would net 0 less expenses. It gained from the overall risk of owning gold/bonds/stocks over a particular period. It was, in essence, overall a good value buy for that period.

However, if you think it intelligent to state that gold/bonds/stocks now have historically little upside, then it follows that the future returns from the risks inherent in the PP will NOT resemble the past at all, rather the opposite. Is it truly just a totally random guess to say those 3 PP categories will trend poorly over the next 5 years or so even if we can't predict what will happen along the way? If my sports team has won for many years I'm going to keep betting on that; if however I see all the best players are now old and injured I am foolish not to re-evaluate and bet on who I think will win. Or maybe you think things will continue to trend well?

Replying that we don't know about highs and can't know what will happen next but, in any case, the PP has churned out a gain in the past is simply ignoring the point being made: what exact risk did that gain come from in the past? Or if we reply, "Well, it won't necessarily make a gain, every portfolio is a risk!", we finally acknowledge that the system is based on the risk of owning those particular assets, not a magic formula that simply works out.

So: that risk needs to be clearly focussed upon and outlined, not the magic formula, then evaluated against the current situation and our ideas about the future.

There's no getting around that with fancy word-play or pleas of ignorance. If you try to do so while advocating the PP, you're really just hiding behind a "perpetual motion" theory of how the PP works: Put the money in, lock the door, presto-chango, you made 9%! Don't ask me what happened!

Well, I want to know exactly why it happened, then think whether it will happen some more, and compare that to other portfolios.

In general, I think a couple things hurt the valuable discussion here:

1) the data using gold from around 72 should not even be listed, it is highly irregular and misleading. Scrub it and all discussion of returns based upon it, make it a footnote, and only use figures starting later. (Can someone remind me the PP gains from, say, 81 to present?)

2) the entire "we-can't-rely-on-the-past-or-know-what-will-happen" line is largely disingenuous. Certainly we hedge to limit losses and the PP does that well, but the only reason to buy the PP is because of past performance and reasoning that it will continue. That's exactly how we compare portfolios. Why not buy TSM or pokemon collectibles if we truly can never know what will happen? Well, because we are making judgements about the present and future and using the past to help us do so. 

OK, survival of the fittest.   Please show me how that reasoning is horribly wrong.

Have you read any of HB's writings or listened to the archived radio shows?  If not, I would suggest it as time well spent.  In response to your points 1 and 2 above, I would offer the following commentary: 1) I do not believe it took the market 9 years to reach a consensus on the market value of gold when the standard was dropped.  If so, should we also eliminate those down years after 1981 where the market was "adjusting" the value due to the fact that it overvalued gold during the 9 years?  While we are at it, should we also look at special economic circumstances surrounding the various bull/bear run(s) in stocks and bonds during any back-test period?  2) I can't speak for anyone else, but I disagree with your assessment that the only reason to buy the PP is past performance.  I invested in it due to what I believe is the sound economic theory behind the model.  The fact that it back-tests well is nice and helpful.  If one is only interested in past performance, why not just use the Simba spreadsheet and the excel solver function?  There are plenty of portfolio's with higher projected reward (albeit with higher SD).

There is nothing "magical" about the PP.  It is based upon sound economic principals that highlight the value of diversification.  Could these assets become correlated when the world changes?  Sure, but the theory behind the portfolio is sound.

[Plurimus]

Allow me to try to answer the question "what causes PP to go down"

I backtested on this Sunday the US PP including GLD, VTI, SHY and TLT since end of 2004 and there were 2 big drawdowns in 2008 and 2009 (as always, the spreadsheet is freely available under www.plurimus.net/blog)

During that time VTI plunged and the GLD and TLT didn't rise sufficiently to offset the dramatic stock market plunge.
I was negatively surprised that during this time the PP maximum drawdown was -17.44% according to my calculations, although this is obviously still much better than being in the stock market during that period, which probably was a historically bad stock market plunge.

[Plurimus]

Dear Clive,

Many thanks for your post.  I uploaded the U.S. PP excel now, which you can download now.  Thanks for pointing it out. 
I will study your Excel, which is probably a bit more sophisticated than mine. So give me a bit time 

[Plurimus]

Regarding your note before:
My data includes for every calendar day a price, so when there was no trade or a weekend or a vacation, then the tool just took the previous day closing price.

I think the explanation to our differences is quite simple. There is a difference between our data price feed in TLT, SHY and VTI.  GLD is identical somehow.  Maybe your data feed is adjusting for dividends and therefore more correct?  Do you know if that is the case? 

[stylo]

I disagree with your assessment that the only reason to buy the PP is past performance.

Except that's not what I said. I said "the only reason to buy the PP is because of past performance and reasoning that it will continue. That's exactly how we compare portfolios." The point is that the "we-can't rely-on-the-past-or-know-the-future" reasons are disingenuous. If you do buy PP only because it is very hedged for the future, you are ignoring that it not neutral, just a bet you don't understand. And by "you" I mean me, of course

There is nothing "magical" about the PP.  It is based upon sound economic principals that highlight the value of diversification.  Could these assets become correlated when the world changes?  Sure, but the theory behind the portfolio is sound.

Beyond a few comments buried here and elsewhere, I've yet to see much in hundreds of pages about the theory of how the PP actually makes its gains, i.e., what risk it is betting on, only about how it is uniquely hedged along the lines of "Put the money in, lock the door, presto-chango, you made 9%! Don't ask me what happened!"

Well, something happened. What? Browne's comment that the reaction is greater than the action is far too casual and dubious.

For example, with TSM it is very clear what you are considering betting on. You look at past returns, then evaluate the present market and your anticipated future and go from there. Is it crazy to put $500,000 in TSM right now?

Well, what about $500,000 in PP? With PP it is exactly the same, with the exact same need to evaluate the past, present and future, except it is simply unclear what the actual bet is beyond the excellent hedging.

More discussion of what that non-neutral bet is, and less of the "Put-it-away-and-forget-it" would be very helpful in evaluating if the PP is a good thing to put your money into now given what you anticipate.

For example, as Clive just wrote:

In effect we have four assets that generally pace inflation as a set. Individually there are differences but as a set we might assume that they pace inflation relatively well.  The indications are that there is also around a 1.5% rebalance benefit.

Historically the PP returns have further been assisted by base rate high to low transition (as has most/all other investments).

Take away the high to low base rate transition benefit of around 3.75% and PP returns are perhaps more likely to be of the order of 6% to 8% type amounts assuming similar levels of inflation to that historically encountered since 1970's.  With lower inflation that would decrease further e.g. at perhaps 3% inflation PP rewards might be around 5% to 6% perhaps.

In many respects the PP is a form of inflation pacing investment that captures some additional benefit out of rebalancing. A risk is that base rates transition from current lows to highs.  Typically when such events occur the upward move in base rates is a lot quicker than the prolonged down moves in base rates.  Cash and gold are in part less affected by such large/rapid rises in base rates, which means that losses are only endured on half the investments and the losses are therefore half that of other investors who might solely be invested in stocks and bonds.  There's also a reasonable chance that both gold and cash might do well during such periods.

I think the only reasonable stance is that the relatively high rewards since 1972 are much less likely to be reflected in the forward time direction due to having less of a high to low base rate transition benefit and low levels of inflation.  That is up until there may be a sharp rapid rise in inflation/base rates during which the PP might endure a poor year or two of perhaps -12% type declines maybe.  Thereafter likely another new repeat of 1970's to recent slow transition of declining base rates might further add a beneficial bias.

Now, that is very helpful and exactly what I am asking about! It suggests that, based on how PP actually makes money, now is possibly the worst period for investing in it. Then compare with other portfolios.

I have no idea if correct, but that doesn't mean we're excused from thinking about it. 

[craigr]

Thanks.

As someone just beginning to educate himself on portfolios, let me play devil's advocate for a moment as best I can. Please critique me.

My main concern is that the gains from the risk in the PP have been dangerously obfuscated in favor of magical portfolioism.

There's no magic to it at all. The markets tend to react to certain situations in certain ways. When deflation is coming people want bonds paying higher interest than what they think the markets can provide. When inflation is expected the markets want hard assets to protect against losing values. Etc.

What the Permanent Portfolio does is stake out a claim in the four basic economic cycles. When the market comes calling the holder of the assets can profit by riding up the enthusiasm and selling out to rebalance into the laggards. As sentiments change or crises in the market happen the money moves around but always the holder of the Permanent Portfolio will have something everyone wants so it can be sold for a profit. Over time this profit compounds along with dividend and interest growth from the stocks and bonds.

It was, in essence, overall a good value buy for that period.

Yes one asset is going to be a better value than another at any point in time. I agree. But the problem is we just don't know what the good value is ahead of time. My personal opinion on the subject doesn't matter because the markets set the prices on the assets, not me. I'm just one person out of millions deciding these things.

So in a way the portfolio is set and forget because the basic premise is the future is not predictable and the asset prices cannot be timed effectively.

What I found after I adopted the portfolio is that it took me a few months to really get out of this mindset of worrying about it. Sure I knew the history and the theory behind it and spent a long time researching it. Yet you do have this kernel of worry wondering if you made the right choice. Well, when the market crashed in 2008 and the portfolio largely shrugged it off that kind of sealed the deal for me. Sure I had all of this historical data showing it responded in a robust way, but here it was doing exactly as described in economic theory in real-time with real money.

Gradually I just came to trust the design over other alternatives which brings me to my next point:

What alternatives are better?

I put this in bold because that's the question I always ask when presented with alternatives. I need to know what approach is better, why it is better, why it is expected to be better going forward, how it handles risks, what economic theory is it based on, how has it responded to various economic cycles in the past, etc. When I look at other approaches and ask these questions I'm left with a lot of blanks to fill in and many risks that the advocates are disregarding. Not just this, but many times I can look at the historical data and see clearly where the approach being advocated has completely blown up. Yet this failure is just assumed to be an anomaly and not something which may repeat (and they usually do repeat). Stock and bond portfolios strike me as this kind of failed-in-the-past-but-we'll-ignore-it mentality. I know looking at these other designs that they've taking huge losses. I know they've had negative real returns for a decade+.

These are total failures in the portfolio design from my perspective so I just disregard any portfolio approach that advocates these things. If I have an approach right now that has shown to have nearly identical returns to much riskier strategies with very little comparable volatility and losses why shouldn't I ignore these approaches? They aren't providing any improvement in what I already have and introduce many more risks. 

If my sports team has won for many years I'm going to keep betting on that; if however I see all the best players are now old and injured I am foolish not to re-evaluate and bet on who I think can win going forward. Or maybe you think things will continue to trend well?

I don't expect trends at all. I think the markets are just random noise with occasional spikes up and down. It may be that bonds, gold and cash have some fatal flaw I have overlooked. But again I would ask: What alternatives are better? What will give better return? What has less risk? What is a better value right now? I don't know these answers so I distribute my bets among assets with a certain track record to do well no matter happens. I don't know if gold is the best inflation protection for instance, but it's been pretty darn good over time at matching inflation and rising sharply during inflation induced market panics. I'd be happy to listen to alternatives, but the ones people usually state (like TIPS) just don't cut it for me. These other alternatives all have risks worse than gold, or bonds or cash for each respective market cycle.

Replying that we don't know about highs and can't know what will happen next but, in any case, the PP has churned out a gain in the past, is simply ignoring the point being made: what exact risk did that gain come from in the past? Or if we reply, "Well, it won't necessarily make a gain, every portfolio is a risk!", we finally acknowledge that the system is based on the risk of owning those particular assets, not a magic formula that simply works out.

I don't think there is magic involved. Sometimes the markets really want a particular asset and will pay above value to get it. Whether it is stocks, bonds, gold, cash, etc. The only thing the portfolio is doing is positioning the investor in such a way that they will have a product the market wants at all times. YES, these assets all have unique risks. YES, you are making money by taking these risks. However you are also being protected against specific risks by owning assets that can balance out losses. Investing is not a science and most of the time the markets overreact to events. The market may get euphoric over stock prices and drive them to astronomical levels. Or it may get overly bearish on the dollar and drive up gold prices. Or it may think that interest rates are crashing and drive up bond prices. Over time these excesses can be harvested with rebalancing and this can grow the portfolio along with the growth in stock dividends and bond interest.

1) the data using gold from around 72 should not even be listed, it is highly irregular and misleading. Scrub it and all discussion of returns based upon it, make it a footnote, and only use figures starting later. (Can someone remind me the PP gains from, say, 81 to present?)

I have posted CAGR starting from 1974 because of the broken gold standard causing disruptions in 1972. I don't think it is correct to wait until 1981 when the gold bubble crashed to start the comparison because the markets do not take nine years to adjust prices. The late 1970s gold price spike was due to the falling dollar, not purely a result of Bretton Woods failing. But since you asked, yes I have looked at it because I too am interested in worst case results and 1981 was the year the gold price crashed by almost 1/3rd:

1981-2009 CAGR: 8.20% (1981 was the worst loss for the portfolio being around -4-6%)

2) the entire "we-can't-rely-on-the-past-or-know-what-will-happen" line is largely disingenuous. Certainly we hedge to limit losses and the PP does that well, but the only reason to buy the PP is because of past performance and reasoning that it will continue. That's exactly how we compare portfolios. Why not buy TSM or pokemon collectibles if we truly can never know what will happen? Well, because we are making judgements about the present and future and using the past to help us do so. 

I should clarify that I only look at backtested results to see what didn't work. It can't prove anything going forward. I can look at the past and answer questions like "Has this portfolio ever turned in a 10 year period of negative real returns?" or "How much has this portfolio lost in the past?" or "How did the portfolio do when these economic situations were present?"

But NO you cannot look at the past to know what will happen. Period. You just can't. You can use it to make educated guesses about the future or see how the portfolio did prior when similar things happened. But this doesn't guarantee it will repeat. However it's not totally useless either. Backtesting is a tool that needs to be used properly. It's like a firearm. In the hands of a trained person it can do very useful things. But in the hands of the unskilled it can blow of their foot (or worse).

So we can't answer the question everyone wants to know about maximizing future returns (hunting for the elusive "efficient frontier" of assets for instance). This is the question that everyone looks to backtesting to try to answer, but it's the only thing it actually can't do. It's the kind of data mining that blows off your foot (or worse).

OK, survival of the fittest. Please show me how that reasoning is horribly wrong. 

I would turn the question around. I've seen an awful lot of portfolio ideas (with an emphasis on awful ). Please illustrate one that can provide consistent real after-inflation returns, a history of low draw-downs and volatility, wide diversification against many economic scenarios and does not rely on market timing or elaborate voodoo trading systems? If you start to consider these and other relevant questions you'll find that the field narrows considerably.

[craigr]

Beyond a few comments buried here and elsewhere, I've yet to see much in hundreds of pages about the theory of how the PP actually makes its gains, i.e., what risk it is betting on, only about how it is uniquely hedged along the lines of "Put the money in, lock the door, presto-chango, you made 9%! Don't ask me what happened!"

The portfolio makes gains in three ways as explained by Browne and others:

1) Dividends
2) Interest
3) Capital appreciation

Obviously you have growth components like stocks and bonds that are generating their returns through dividends and interest (and cash as well to a smaller degree). Assets like gold will grow with capital appreciation as it obviously does not generate dividends or interest. But bonds and stocks can also grow with capital appreciation above their other return factors.

So you are taking risks in these assets. But the issue is that you are falling into a mindset of looking at assets in isolation which is a big mistake in a diversified portfolio. I can make a case for any asset at any time being over/undervalued. But we won't know what it is until years later. However the more important question is how the assets perform when mixed together. Sodium is toxic and so is chlorine. But when put together you get salt which is a necessity to life. So looking at individual portfolio components and not considering how they mix together in a diversified portfolio can cause problems.

Now, that is very helpful and exactly what I am asking about! It suggests that, based on how PP actually makes money, now is possibly the worst period for investing it.

I have no idea if correct, but that doesn't mean we don't have to think about it.  

And again I can make this case for any asset at any time. There is a confirmation bias where humans tend to seek out information that confirms their own beliefs. So if I'm bearish on stocks I pay more attention to the chicken littles. If I'm bearish on gold I look for articles ridiculing people buying gold. If I'm bearish on bonds I read articles highlighting the debt of the US. Etc.

In the portfolio at any one time you're usually going to have one or more assets that may be overpriced and could drop in price dramatically. But again when you look at the portfolio as a whole this has largely been a non-issue because other assets have rebounded and erased the losses. In 1981 we had a gold price crash of almost -33%. yet the portfolio didn't take a huge loss even though the other assets didn't rise that much that year. But in 1982 stocks rose 20+% and LT bonds 40% wiping out these losses easily. Gold dropped again in 1983 by -16% but stocks were up over 21% wiping out the losses again and turning a profit. In 2000-2002 stocks took heavy losses but gold and LT bonds rose and wiped out the losses and turned a profit. Same thing of course in 2008 when stocks dove but bonds rose in price to overcome and turn a profit. Then in 2009 LT bonds dropped over 20% but stocks rose almost 30% erasing the bond losses and turning a profit. Then on top of this you have the dividend/interest growth in the assets as well compounding returns.

At any one of those dates I could have picked an asset and proclaimed it was the worst time to invest in it. Let's even say that somehow I was prescient enough that I was even right 100% of the time. Guess what? It didn't matter because the losses were still erased. Because the portfolio is made up of multiple assets you can't look at each one in isolation. If you do that you will immediately begin to fret about each component and attempt to put a value on it that you think it should be. But here's the important part and I'm not trying to be ugly, just truthful: The market doesn't care what your opinion is on the subject. The market is going to price these assets for what it thinks they are worth and you're just one person out of many millions who has a say in the matter. If the market ends up not agreeing with your assessment then you can get badly burned. You can get burned because you concentrate your wealth into a "sure thing" asset that gets a severe haircut. Or you could get burned by missing out on big gains in an asset that you just refuse to buy.

So again I would say that it is important to look at the portfolio as a whole. If you think all of the assets are way overpriced it may not be for you. But then I would ask "What are you going to do instead and why is it a better idea?" I don't say this to be confrontational. It's really something for your internal dialog to help eliminate bad choices. If it happens that you have a plan that you think works better for you than the Permanent Portfolio I don't have any complaints.

[stylo]

Most of your answer reverts to hedging again. I get the hedging. I like the hedging. Put the hedging aside.

The portfolio makes gains in three ways as explained by Browne and others:
1) Dividends
2) Interest
3) Capital appreciation

That's a bit like saying the gain comes from gains, no? But how so with the components purposely hedged against each other? If I buy TSM, short TSM and buy bonds, you wouldn't say my overall portfolio gains are from those 3 items because you'd clearly see that only bonds contribute overall gain in such a portfolio. It is quite complicated to understand what the overall weighted bet in PP is.

I don't believe Browne's mechanical explanation that the reaction simply outweighs the action and returns some profit. Clive has posted some analysis of what PP is weighted toward overall. I don't see much else.

Yes one asset is going to be a better value than another at any point in time. I agree.

No, I was speaking of overall gain, not one component.

But the issue is that you are falling into a mindset of looking at assets in isolation which is a big mistake in a diversified portfolio.

No, I'm really not, and clearly explained that. I'm explicitly asking what the overall combined bet is beyond the combined hedging. If all is equally hedged, there is no profit. I think people are tending toward "magical portfolioism", focusing on the formula and believing it just makes gains overall without analyzing exactly what type of bet you're making here.

What alternatives are better?

That's absolutely impossible to answer until you know what the PP is weighted towards, review the past, evaluate the present, estimate the future, and compare portfolios. Again, why not pokemon collectibles if you know absolutely nothing about the future? Because you know some basic things and will think through others.

Everyone agrees we don't know everything exactly but without estimating we are betting blindly on any portfolio, if perhaps conservatively with the PP because of the very interesting hedging record in the past.

For example, Clive's analysis, if one accepts it, shows PP gained from specific conditions before but won't do nearly as well given the present and you'd be better off with a portfolio weighted otherwise going forward. Either fly blind or think about it.

I don't say this to be confrontational.

I assume that goes without saying for everyone engaged in civil discussion.