75% Of PP assets have Zero or Negative Expected Real Return

[TripleB]

A post on Bogleheads today about gold having no real return sparked me to draft a response that I believe the PP community would enjoy:

I'd argue that Cash and Risk Free Bonds have zero (real) return too. In fact, the return may be negative.

Cash is yielding 0% to 1% depending on where you invest it. Inflation is 2% to 3% depending on how you calculate it. That's a real loss of purchasing power.

Risk Free Bonds are yielding 2% to 3% depending on duration. Compared to inflation, you are either netting 0 or have a slight loss.

TBM is not risk-free. Is has non-treasury bonds in it.

That said, I'm doing pretty well with the Permanent Portfolio of 75% assets that have a real return of 0. In fact, PP is beating just about every Boglehead portfolio out there. No guarantee it will continue going forward, but I'll take my chances.

Why is PP doing so good with 75% of assets producing nothing on an inflation adjusted basis? Because "Real" return of a single asset is meaningless. Here's why:

Gold responds to devaluation of the dollar. When this occurs, gold increases tremendously. When this happens, it triggers a rebalancing event so you sell some of the gold at a profit. Thus the return becomes positive.

Long Term Treasuries respond to drops in interest rates. When this occurs, bonds increase tremendously. This triggers a rebalancing event so you sell the bonds at a profit. Thus the return is positive.

Cash just sits there. Relative to cash, it's just cash and of course is neutral. But relative to other assets, holding cash provides "option value" to purchase assets that decrease. If the dollar strengthens, gold drops in price. If interest rates rise, bonds drop in price. When the economy sucks, stocks drop in price. There's "option value" in sitting on cash such that when another asset drops in price, you can purchase it with some of the cash, and "lock in" the low price, to eventually profit off it. Cash itself is losing money when looking at interest, But if you calculate "option value" of sitting in cash, it becomes positive when used as part of a whole portfolio.

If you buy a gold coin now, and in 30 years sell it when you need money, and use that money to buy something, you probably have 0 real return and could buy the same thing with that coin in 30 years that you could buy now.

If you buy a 30 year treasury bond now, hold it to maturity, and spend the proceeds plus interest payments, you can probably only buy the same thing in 30 years that you could buy now.

If you put a chunk of money into a savings account or CD and pull it out in 30 years, you will have slightly less purchasing power in 30 years than now.

Yet, the PP still manages to produce 10% CAGR over the last few decades. Why? Because of the reasons explained above. Assets should not be looked at in isolation They must be looked at with respect to being part of an entire portfolio where rebalancing events occur, trigger sales of assets prior to the "spending" phase.

[longeyes]

Clive, could you spell that out in actual ETFs and percentage allocations?

[christina]

If you want to turbo charge a PP, try swapping out TSM for Small Cap Value to capture 3 factor model benefits. And swap out T-Bills for a 5 year T ladder. Also split the 25% gold allocation down into 12.5% 2x Gold and 12.5% 2x Emerging Markets.

For not a lot more volatility the actual gains historically have been significantly higher (close to 16% annualised).

So, in a nutshell, all of these assets tend to move in quite opposite directions, creating the largest zig zags possible, thereby allowing you to buy really low and sell really high more often, thus causing you to make more money (ie: 'lock in volatility capture gains')? Is this about right?

So conversely, are you saying that the PP would have more zig zags, and that the zig zags could be much bigger, if you included emerging markets, 5 year T ladders, and small cap value stock into your PP portfolio?

[stone]

christina, I'd be ever so wary of replacing gold with a 2xgold leveraged etf. The etf is forced itself to buy high and sell low so as to maintain the 50%:50% ratio of gold to debt whenever the market moves. That is why such funds say that they try and track 2x the DAILY price rather than claiming to track the 2x price long term.
Personally I think it is safest to keep your gold allocation as "normal" as you possibly can.

I do myself deviate from the standard stock recommendation by holding it as equal amounts of three investment trusts, one small cap, one emerging market and one large cap dividend  (I'm UK based and they are  BRSC.L, TEM.L and CTY.L). My hope was that the somewhat independent volatility of those would mean that I ended up buying low and selling high like you describe.

As a general rule, I think the standard PP is something to be wary of straying from. Clive keeps us all on our toes with a constant stream of arguments about how the standard PP is out of whack. Before the latest run up in bond prices, Clive's key suggestion was cut out the LTT. I'm very glad I didn't (Clive I hope its OK to bring this up again ).