The Key to the PP: 25% Gold

[SmallPotatoes]

Truly, the hallmark of the PP is its 25% allocation to gold. Me thought this the other day: take any other lazy investment strategy and squeeze in 25% (or any arbitrary fixed %) gold and see how it does. Conversley, has anyone tested the PP as just 33-33-33 TSM/LTT/STT? 

I guess what I'm curious about is what effect having a fixed % of gold and set rebalancing might have on any other strategy, as well as its potency in the PP.

[moda0306]

I would say that gold makes the PP behave differently than most portfolios, but I'd say long-term bonds come in at a close second.  "Bonds" as a term is very vague.  I'd say 2008 showed how imprtant the LTT distinction really is.  Not saying I disagree... Just that the distinction of what kind of bonds the PP has is unpopular and uncommon.  The distinction of gold vs other commodities, too, is very important when it counts.

[Indices]

Harry Browne wrote in "Why the Best Laid Plans..." that he added gold to the portfolio because in the early 80s you saw high inflation which ruined the bonds, and a fall in equities: classic stagflation. In that scenario the only asset that appreciated in value was gold.

[SmallPotatoes]

Not that I wish to meddle the PP mixture, but I'm just curious to see how a PP sans gold (3x3 of Stocks, LTT, and Cash) would do by comparison... you know, for science.

Also, take a typical, conservative Boglehead portfolio of Stocks (Dom & Int.), at about 60%, toss in the bond portion of 30% with Total Bond (or even the Interm. Term Treasury), then add 10% gold, and keep a -/+ 10% rebalance band, how does this compare to a portfolio without gold, or with TIPS instead?  That's what I'm curious to know.

What it all comes down to is the burning question: should every portfolio have some exposure to gold?  If it can be proven that every portfolio that did well the last several year would have done better with some exposure to gold then the myth can be removed and HB will have won the day.

[Pkg Man]

What it all comes down to is the burning question: should every portfolio have some exposure to gold?  If it can be proven that every portfolio that did well the last several year would have done better with some exposure to gold then the myth can be removed and HB will have won the day.

Well, according to the guest host on Bob Brinker's Money Talk show, up to 4% in gold is ok, but the 5% recommended by other financial advisors is too much...

[Drewskers]

Actually there are a lot more differences than the gold allocation and I think they are just as consequential. William Bernstein's The Four Pillars of Investing is pretty much the bible (or at least the "new testament") of buy & hold investing. I followed his guidelines for a number of years, and here's what I see as major differences.

First of all, Berstein's allocation changes with the investing horizon. If you are young (and can stomach the volatility) you go with 80% stocks and 20% bonds, this ranges down to 20% stocks and 80% bonds as you get older. 60% stocks and 40% bonds is the defacto standard. The rule of thumb though is you put your age (expressed as a percent) into bonds and the rest into equities. So a 55 year old should have 55% bonds and 45% equities. The PP allocation is static and does not change!

Second, Bernstein's stock allocation goes to about 70% US stocks (highly overweighted with value and small caps, and throw in some REITs for good measure) and the rest goes to foreign developed and emerging markets (again overweighted with value). The PP has no foreign/emerging stocks and also does not overweight styles; REITs are also not part of the PP as Harry Browne wrote about it.

Third, Bernstein's allocation to bonds is generally to a broad bond index such as BND or AGG. He specifically says "keep it short" to avoid interest rate risk. He does suggest some investment grade corporates but again "keep it short". These allocations are substantially different than the long term treasury allocation in the PP, and in fact can be highly correlated to US equities in times of trouble, where the long term treasuries shine in the PP.

Fourth, CASH is a very limited allocation in Berstein's book and pretty much limited to "emergency funds" for which he recommends 2-3 months of living expenses. This is a HUGE difference from the PP's allocation of 25% cash (or short term treasuries)!

Lastly, Bernstein recommends no more than a 2-3% to precious metals and then they go to precious metal miners, whereas the PP calls for 25% bullion.

The more I live with the PP, the more I come to understand it is a radically different animal than the typical "lazy" buy and hold strategy.

[SmallPotatoes]

Excellent analysis Dew'.  I think you've pinpointed where the standard buy'n'hold and PPhilosophy diverge.

Perhaps it's foolish to ask if gold should belong in every portfolio, but I can't help wonder.  As has been said it really depends on the strategy.

[AdamA]

Actually there are a lot more differences than the gold allocation and I think they are just as consequential. William Bernstein's The Four Pillars of Investing is pretty much the bible (or at least the "new testament") of buy & hold investing. I followed his guidelines for a number of years, and here's what I see as major differences.

The Four Pillars of Investing is a fantastic book.  I don't think I would have understood the theory behind the PP had I not read it.  I'm surprised Bernstein isn't more of a gold or PP advocate, given that the PP seems to flow naturally from a lot of his theory (although I the most recent post at his website is about the PP). 

[MediumTex]

Actually there are a lot more differences than the gold allocation and I think they are just as consequential. William Bernstein's The Four Pillars of Investing is pretty much the bible (or at least the "new testament") of buy & hold investing. I followed his guidelines for a number of years, and here's what I see as major differences.

The Four Pillars of Investing is a fantastic book.  I don't think I would have understood the theory behind the PP had I not read it.  I'm surprised Bernstein isn't more of a gold or PP advocate, given that the PP seems to flow naturally from a lot of his theory (although I the most recent post at his website is about the PP). 

I have not read the book, but does Bernstein make any distinction between stock investing during secular bull markets vs. secular bear markets?

I wouldn't have minded being 80% equity (regardless of my age) if I was starting in 1982, but I definitely would NOT want to have 80% equities if I was starting in 1966 or 2000.

The poor Japanese investor who maintained an 80% stock allocation beginning in 1989 would have had a miserable experience in the ensuing decades.

To me, if you are going to overweight equities, you almost have to evaluate what type of market you are buying into.

[MediumTex]

Clive,

Note that I was talking about 80% equities being miserable for the Japanese investor.

[AdamA]

I have not read the book, but does Bernstein make any distinction between stock investing during secular bull markets vs. secular bear markets?

He discusses an awful lot of financial history in the book, and, yes, he makes this distinction.  He mentions several times that he would not be surprised to see the bond market outperform the stock market over the next decade (but is careful not to sound like a pundit).  He is an advocate of diversification (specifically bonds) and rebalancing (similar to that which is done with the PP). 

His bare bones strategy is basically 35% US stocks, 12.5% EFA, 12.5% emerging markets, and 25% bond index (percentages aren't exactly right, but I can't remember exactly...).  You'd rebalance annually.

He gets into more complex portfolios...some of which involve small precious metals/mining allocations (I think). 

...but the good thing about the book (or his books in general) isn't the portfolio recommendations, it's the simple explanation of why noncorrelated assets are a good thing, why you don't want to be invested in stocks only, and (most interesting) the history discussed. 

He's not really advocating a system (like the coffee house or gone fishin' portfolios), more just discussing the yin and the yang between stocks and bonds. 

There is also some good stuff about recency bias, survivorship bias, and the folly of chasing the efficient frontier. 

[SmallPotatoes]

So maybe'non-correlated' is the key rather than gold. However, any broker will tell you about the rise and fall of stocks and bonds.  Perhaps a clever broker might mention commodities or real estate, but rarely until recent years has GOLD been brought up so much.

For me it comes at a perfect time.  I sleep well at night my investments march on and upward regardless, and my hard assets n'er far away just in case. But, when I have hinted about my investing style to others it is always gold that is so harshly rejected.

I think now I can better explain how any portfolio may be improved by gold.

[MediumTex]

I think that the opposition to gold in general is also an interesting study in the way bull markets unfold.

At first, everyone hates the asset, then gradually people come around to it, until finally everyone loves it, which probably means you are near the end of the line.

Part of the reason I think that we are not at the end of the multi-decade bull market for bonds is that there are LOTS of people who still hate them, which means there are LOTS of potential buyers out there to be won over.

As for stocks, until EVERYONE hates them, I don't think we will be at the bottom of this secular bear market that started in 2000.  When I look at a stock like Microsoft, however, the secular bear market P/E compression is unmistakable (which suggests we may be closer to the end of the bear market than the beginning).  Microsoft has had solid earnings over the last 10+ years, yet the stock has done nothing (ditto for Berkshire Hathaway), and currently trades at a P/E under 10, even though it is enjoying double digit revenue and earnings growth.

[moda0306]

MT,

Do we see any of that same P/E compression in Japan? 

[MediumTex]

MT,

Do we see any of that same P/E compression in Japan? 

22 years later and 75% below the 1989 levels I would certainly hope so.

[cowboyhat]

Bernstein's excellent critical review of the PP can be found at the link below. It has been posted by others in the forum before. Bernstein's criticism is worth reading and re-reading because he is so obviously well informed and thoughtful, and because it is a useful tonic if you are starting to feel comfortable with the PP.

http://www.efficientfrontier.com/ef/0adhoc/harry.htm

[MediumTex]

cowboyhat,

That's a great article.

The most dangerous thing about the PP is the ever-present temptation to tinker or simply abandon it in favor of something more flashy.

[AdamA]

Bernstein's excellent critical review of the PP can be found at the link below. It has been posted by others in the forum before. Bernstein's criticism is worth reading and re-reading because he is so obviously well informed and thoughtful, and because it is a useful tonic if you are starting to feel comfortable with the PP.

http://www.efficientfrontier.com/ef/0adhoc/harry.htm

That's the article that initially turned me on to the PP.

I re-read it all the time.

[SmallPotatoes]

Bernstein's excellent critical review of the PP can be found at the link below. It has been posted by others in the forum before. Bernstein's criticism is worth reading and re-reading because he is so obviously well informed and thoughtful, and because it is a useful tonic if you are starting to feel comfortable with the PP.

http://www.efficientfrontier.com/ef/0adhoc/harry.htm

Excellent article. Once you go PP it's hard to imagine putting your money in anything else.

[Lone Wolf]

http://www.efficientfrontier.com/ef/0adhoc/harry.htm

This is a great analysis \ critique of the Permanent Portfolio.  You can tell that Bernstein really "got it".  This is why his criticisms are so much more on target than the typical, "It's crazy to be 25% in stocks when Everybody Knows that we're about to enter the mother of all bull markets!"

The danger of capitulation in the face of a huge stock bull market has to be one of the biggest trouble spots that the PP faces.  The temptation to bail on the PP's "boring returns" when stocks are going crazy is bound to be overwhelming.  If there's one thing I think any PP investor should be ready for, it's this.

The way I look at is that when the stock market is going crazy and times are good, my career is more likely to be doing well also.  Likewise, I do not want a stock-heavy portfolio that will suffer during hard times when the economy and job market are at their bumpiest.

[moda0306]

LW,

What you touch on with the job market is exactly why I don't buy the strategy of putting young people in a stock-heavy portfolio just because it will probably have the best long-term results.  If one is highly dependent on the job market for income, their "portfolio" is made up much more of their skills and time than their money.  The demand of these skills and time, depending on industry, will follow the stock market more than any other single asset class, most likely.

Personally, I feel a collapsing job market, not a measly return on my wealth, is my biggest threat to overcome, even if I'm not overtly unemployed, underemployment is a big problem.

[Lone Wolf]

Personally, I feel a collapsing job market, not a measly return on my wealth, is my biggest threat to overcome, even if I'm not overtly unemployed, underemployment is a big problem.

Yes.  Note that you (correctly) said "biggest threat" not simply "biggest threat to my investment portfolio".  What I think we're all really trying to do with our investments is create happiness and stability for the short- and long-term.

When the game you're playing is to hedge against everything, the story behind the 25% stock allocation kind of tells itself (particularly in the context of Browne's rule that your career is the true builder of your wealth.)

[AgAuMoney]

Harry Browne wrote in "Why the Best Laid Plans..." that he added gold to the portfolio because in the early 80s ... the only asset that appreciated in value was gold.

Hmm.  NY Market price for gold:

1975    161.49
1976    125.32
1977    148.31
1978    193.55
1979    307.50
1980    612.56
1981    459.64
1982    375.91
1983    424.00
1984    360.66
1985    317.66

sdb

[MediumTex]

Harry Browne wrote in "Why the Best Laid Plans..." that he added gold to the portfolio because in the early 80s ... the only asset that appreciated in value was gold.

Hmm.  NY Market price for gold:

1975    161.49
1976    125.32
1977    148.31
1978    193.55
1979    307.50
1980    612.56
1981    459.64
1982    375.91
1983    424.00
1984    360.66
1985    317.66

sdb

I'm not sure what Indices was getting at with the original comment, but it was probably something about gold doing well in the 1970s as inflation raged and stocks and bonds were struggling.

[AgAuMoney]

As for stocks, until EVERYONE hates them, I don't think we will be at the bottom of this secular bear market that started in 2000.  When I look at a stock like Microsoft, however, the secular bear market P/E compression is unmistakable (which suggests we may be closer to the end of the bear market than the beginning).  Microsoft has had solid earnings over the last 10+ years, yet the stock has done nothing (ditto for Berkshire Hathaway), and currently trades at a P/E under 10, even though it is enjoying double digit revenue and earnings growth.

In general the entire large-cap tech sector is like that...  http://tech.fortune.cnn.com/2011/05/26/ ... -are-lame/

I think until you start getting the P/E of the overall market down, the bear has room to roam.