Article: Is the Permanent Portfolio Broken?

[AdamA]

You and I are alike with respect to the PP.  Study, study and more study.  in the meantime, the world passes us by.  It's time to act or get off the pot.

I think this is a good point. 

As MT has pointed a number of times, so many investors spend their investing lifetime moving in and out of strategies for various reasons (often at exactly the wrong times).

At some point, you just have to pick something you're comfortable with and stick to it.  For me, it's the PP.  For some it's a BH 60/40.  For others, maybe it's just cash equivalents. 

But whatever you pick, you should keep it simple and stick to it.

[stuper1]

I'd say now is a great time for someone who is 100% cash to get into the PP (with whatever portion of your savings you choose).  If you look at a long-term graph of PP returns, the PP has been on a downward trend for a while, which basically means that you are buying low.  It's due to start going up soon, although it may keep going down for a while yet.  Nobody knows.

[systemskeptic]

25% Stocks (US)
SP500 Shiller PE = 26.3.  Historically this has indicated the 10 year returns are likely to be below average.

25% Cash
10 year return for cash historically gives a negative real return regardless of rates (this reduces volatility at the expense of real return)

25% LTT
Right now rates are 3%, will average inflation over the next 30 years be less than 3% a year with all of the bottled up QE we have seen?  10 year returns are likely low/negative even if holding this smooths out volatility in a short term deflation.

25% Gold
Currently downtrending, but it seems the fundamentals for owning Gold are still strong?

Seems that 75% of the PP has low/negative expected returns and the rest of the hope for real return is on Gold which is currently in the gutter... IMHO it sounds like holding a low volatility portfolio with very low expected return.  If that's what you want then it will be a good portfolio.  Personally I would rather have a higher real return and invest in markets with better valuations... the PP may be good over 40 year time frames but right now it seems poised for low returns over the next 10 years -- unless Gold does something crazy.

[stuper1]

Systemskeptic,

What are you investing in to get higher real return over the next 10 years?  Could you give us an idea of percentages you have in different types of investments?

[buddtholomew]

25% Stocks (US)
SP500 Shiller PE = 26.3.  Historically this has indicated the 10 year returns are likely to be below average.

25% Cash
10 year return for cash historically gives a negative real return regardless of rates (this reduces volatility at the expense of real return)

25% LTT
Right now rates are 3%, will average inflation over the next 30 years be less than 3% a year with all of the bottled up QE we have seen?  10 year returns are likely low/negative even if holding this smooths out volatility in a short term deflation.

25% Gold
Currently downtrending, but it seems the fundamentals for owning Gold are still strong?

Seems that 75% of the PP has low/negative expected returns and the rest of the hope for real return is on Gold which is currently in the gutter... IMHO it sounds like holding a low volatility portfolio with very low expected return.  If that's what you want then it will be a good portfolio.  Personally I would rather have a higher real return and invest in markets with better valuations... the PP may be good over 40 year time frames but right now it seems poised for low returns over the next 10 years -- unless Gold does something crazy.

What strategy are you proposing that deviates from a diversified stock and bond allocation? I've always viewed the PP as a conservative portfolio with a portion invested in precious metals to stabilize returns in the event of unanticipated inflation. There is no inflation to speak of, so the decline in gold is expected.

One can shorten FI duration, but there is no guarantee that rates will rise in parallel across the yield curve. We have already seen selling at the short end and buying at the long end as the FED remains accommodative.

International equities are not under-valued according to the 24% YTD return in my VWILX investment. Perhaps REIT and EM are, but do you plan to have 100% allocated to these assets? I already own both and rebalance as needed.

[systemskeptic]

Systemskeptic,

What are you investing in to get higher real return over the next 10 years?  Could you give us an idea of percentages you have in different types of investments?

I think the PP does exactly what it says it does, the problem is all single country portfolios have 10 year periods where they have low returns.  While the US PP may average a 4% real return over 10 years it could also be 0% or 8%. 

Right now I think a foreign investor (say a Euro PP) can expect higher returns just as a result of better valuations in foreign markets.

[Pointedstick]

I think it's really challenging for a lot of people to accept that we're simply in a low-return world right now. Stocks are over-valued. Bond yields are awfully low the world over. Gold got destroyed last year. Cash is yielding nothing. Right now is a hard time for anyone investing in passive funds or broad assets classes. The low-risk, high-yield investment products and portfolios that many became used to are just not there anymore. If you want yield, you have to take a lot of short-term risk. People with stock-heavy portfolios are jumping for joy right now... but how long will the party last? Unless they time their exit well, they could get annihilated.

[systemskeptic]

I think it's really challenging for a lot of people to accept that we're simply in a low-return world right now. Stocks are over-valued. Bond yields are awfully low the world over. Gold got destroyed last year. Cash is yielding nothing. Right now is a hard time for anyone investing in passive funds or broad assets classes. The low-risk, high-yield investment products and portfolios that many became used to are just not there anymore. If you want yield, you have to take a lot of short-term risk. People with stock-heavy portfolios are jumping for joy right now... but how long will the party last? Unless they time their exit well, they could get annihilated.

+1

This isn't to say US PPers are poorly positioned, maybe just below average vs. the history of the US PP.  I think Bogleheads in a 60/40 US portfolio are in for some tough times over the next 10 years.

[buddtholomew]

I think it's really challenging for a lot of people to accept that we're simply in a low-return world right now. Stocks are over-valued. Bond yields are awfully low the world over. Gold got destroyed last year. Cash is yielding nothing. Right now is a hard time for anyone investing in passive funds or broad assets classes. The low-risk, high-yield investment products and portfolios that many became used to are just not there anymore. If you want yield, you have to take a lot of short-term risk. People with stock-heavy portfolios are jumping for joy right now... but how long will the party last? Unless they time their exit well, they could get annihilated.

+1

This isn't to say US PPers are poorly positioned, maybe just below average vs. the history of the US PP.  I think Bogleheads in a 60/40 US portfolio are in for some tough times over the next 10 years.

Substantiate these claims. I've heard the same predictions since 2009 and have outsized returns in a 60/40 allocation over the last 4 years. Realize that your personal opinion of future market performance is detrimental to your investment success, especially if it is pessimistic in nature. Protect for the unexpected, but have enough allocated to equities to participate in times of prosperity. That's the lesson I have learned.

[goodasgold]

I think it's really challenging for a lot of people to accept that we're simply in a low-return world right now.... People with stock-heavy portfolios are jumping for joy right now... but how long will the party last? Unless they time their exit well, they could get annihilated.

Wise words as usual, PS. We should count ourselves lucky when the skeptics start kvetching about the PP after a measly 3-4% loss for the portfolio this year.

As my Mom (God bless her soul) used to say, "Tenacity is a virtue." People like Rick Ferri over at the BH list who are gloating over the alleged "failure" of the PP will eventually learn a thing or two, probably sooner rather than later (although "later" is a possibility, too.)

So hang in there, guys. Time and the stats are on our side. But that doesn't mean that I wouldn't welcome a modest 3-5% real gain for the PP in 2014.... 

[systemskeptic]

Substantiate these claims. I've heard the same predictions since 2009 and have outsized returns in a 60/40 allocation over the last 4 years. Realize that your personal opinion of future market performance is detrimental to your investment success, especially if it is pessimistic in nature. Protect for the unexpected, but have enough allocated to equities to participate in times of prosperity. That's the lesson I have learned.

Unless you believe the time in which you buy into a market is irrelevant, I think it matters when the question is being asked.  Today, the question is "is the PP broken [as of 2013]"  In the last four years we have gone from no monetary easing to $1 Trillion a year.  We have also gone from a Shiller PE of 15 to 26 with a 90% increase in the SP500 over the last four years. 

Now, will the 10 year returns starting in 2009 be different from the 10 year returns starting in 2014?  I would say yes, they will be lower. 

[Pointedstick]

Substantiate these claims. I've heard the same predictions since 2009 and have outsized returns in a 60/40 allocation over the last 4 years. Realize that your personal opinion of future market performance is detrimental to your investment success, especially if it is pessimistic in nature. Protect for the unexpected, but have enough allocated to equities to participate in times of prosperity. That's the lesson I have learned.

60/40 BH-style portfolios have done well because of their heavy stock exposure during a time when the stock market has been booming. By the same token, once the market crashes, such a portfolio is going to fall hard, with the bonds unable to keep the returns positive, and the loss is going to be a lot more than the 3% people are complaining about with the PP this year. That's what I mean when I say that the only real opportunities for good yield these days are with an increase in risk. Compared to the PP, a 60/40 portfolio offers both more upside and more downside.

Basically, what we're seeing is a squeeze in low-risk, high-return assets and portfolios. Since the PP has historically been such a portfolio, the low performance makes sense to me in a world where the only people making a lot of money in the markets are those who are willing to expose themselves to huge risks by making concentrated bets on things like the stock market, real estate, gold, or bitcoins.

[buddtholomew]

Substantiate these claims. I've heard the same predictions since 2009 and have outsized returns in a 60/40 allocation over the last 4 years. Realize that your personal opinion of future market performance is detrimental to your investment success, especially if it is pessimistic in nature. Protect for the unexpected, but have enough allocated to equities to participate in times of prosperity. That's the lesson I have learned.

Unless you believe the time in which you buy into a market is irrelevant, I think it matters when the question is being asked.  Today, the question is "is the PP broken [as of 2013]"  In the last four years we have gone from no monetary easing to $1 Trillion a year.  We have also gone from a Shiller PE of 15 to 26 with a 90% increase in the SP500 over the last four years. 

Now, will the 10 year returns starting in 2009 be different from the 10 year returns starting in 2014?  I would say yes, they will be lower.

Again, only your opinion. How well has it served you so far?

[buddtholomew]

Substantiate these claims. I've heard the same predictions since 2009 and have outsized returns in a 60/40 allocation over the last 4 years. Realize that your personal opinion of future market performance is detrimental to your investment success, especially if it is pessimistic in nature. Protect for the unexpected, but have enough allocated to equities to participate in times of prosperity. That's the lesson I have learned.

60/40 BH-style portfolios have done well because of their heavy stock exposure during a time when the stock market has been booming. By the same token, once the market crashes, such a portfolio is going to fall hard, with the bonds unable to keep the returns positive, and the loss is going to be a lot more than the 3% people are complaining about with the PP this year. That's what I mean when I say that the only real opportunities for good yield these days are with an increase in risk. Compared to the PP, a 60/40 portfolio offers both more upside and more downside.

Basically, what we're seeing is a squeeze in low-risk, high-return assets and portfolios. Since the PP has historically been such a portfolio, the low performance makes sense to me in a world where the only people making a lot of money in the markets are those who are willing to expose themselves to huge risks by making concentrated bets on things like the stock market, real estate, gold, or bitcoins.

I see benefit in both portfolios and decided several years ago to diversify across strategies. I am 70/30 in tax-deferred accounts earmarked for retirement with the balance held in a taxable 4x25PP for short to mid-term expenses. I expect to earn the risk premium in equities over the next 20-25 years. Looking at the portfolio in its entirety, I am 50% equities, 40% fixed income and 7.5% gold and 2.5% precious metals and mining stocks. Seems like a well balanced portfolio to hold for the foreseeable future.

[systemskeptic]

60/40 BH-style portfolios have done well because of their heavy stock exposure during a time when the stock market has been booming. By the same token, once the market crashes, such a portfolio is going to fall hard, with the bonds unable to keep the returns positive, and the loss is going to be a lot more than the 3% people are complaining about with the PP this year. That's what I mean when I say that the only real opportunities for good yield these days are with an increase in risk. Compared to the PP, a 60/40 portfolio offers both more upside and more downside.

From changes in 2013, I'm now about 60% equities, of which I transitioned from 100% US to 0% US over the course of 2013.  Not exactly the best year to do so, but I guess better a year early than a year late...

I've already posted my exact equity allocation elsewhere, for example here: http://gyroscopicinvesting.com/forum/st ... ions/  Instead of owning 1 country I now own 30+

It seems dumb now due to the high returns in the SP500, I guess we will find out in 10 years if it was still dumb or whether valuations mattered.

[Libertarian666]

60/40 BH-style portfolios have done well because of their heavy stock exposure during a time when the stock market has been booming. By the same token, once the market crashes, such a portfolio is going to fall hard, with the bonds unable to keep the returns positive, and the loss is going to be a lot more than the 3% people are complaining about with the PP this year. That's what I mean when I say that the only real opportunities for good yield these days are with an increase in risk. Compared to the PP, a 60/40 portfolio offers both more upside and more downside.

From changes in 2013, I'm now about 60% equities, of which I transitioned from 100% US to 0% US over the course of 2013.  Not exactly the best year to do so, but I guess better a year early than a year late...

I've already posted my exact equity allocation elsewhere, for example here: http://gyroscopicinvesting.com/forum/st ... ions/  Instead of owning 1 country I now own 30+

It seems dumb now due to the high returns in the SP500, I guess we will find out in 10 years if it was still dumb or whether valuations mattered.

I'd be happy just to own an island! Are you issuing passports from any of your countries? 

[portart]

Give me a broken PP that is marginally down and protects me against the eventual market giveback. I played the stock game in the last bull market and got out in time. However there is a difference in being 20 years older and near retirement. I like slow gains whenever they come without panic sell offs in the 20% plus range. PP works for me.

[frugal]

Fellows,

I had a VARIABLE PORTFOLIO as per Boglehead style but I quit it and went 100% PP

I don't like volatility and DRAWDOWNS that's why I went full EU-PP.

The only problem is that I was not lucky with the entry timing.

[Tyler]

I like to picture the PP as being like it's most controversial component -- gold -- while investor sentiment is like a fiat currency.  People like to indulge in the fantasy that their expectations are stable and their portfolios rise and fall according to the market.  When in reality, the PP just does its thing and it's you who is flailing all over the place. 

The PP works very well for me.  This "down" year only reinforced that.

[Latterly]

I wouldn't be too critical of the author. He does get the basic message right: "it doesn't necessarily make sense to give up on a strategy for having a bad year or two."

Although I wouldn't call this a bad year. 2008 was a bad year: -37% return for the S&P 500; -57% from 10/2007 to 3/2009.  In comparison, this year's -1.56% return (YMMV) is no big deal. Show me another portfolio that has such small draw-downs.

IMO the 10-year return is more important than the 1-year return, anyway. The PP's current 10-year CAGR is 6.89%, which is only slightly lower than the current 10-year CAGR of a Boglehead 60/40 portfolio (6.96%). This is the first year since 2007 that the PP's 10-year CAGR hasn't been significantly higher than the 60/40's 10-year CAGR. The PP's 10-year CAGR has been remarkably consistent for the past 20 years, ranging between 5.85% and 8.68%.

The author also correctly states, "It is prudent however to assess a strategy's future prospects." Harry Browne himself, in Why the Best-Laid Investment Plans Usually Go Wrong, pointed out that investment strategies tend to stop working over time. It would not be valid to draw any conclusion from a single year's returns. But I wonder whether the model might be temporarily broken, until the Fed backs out of QE.

Finally, I am reminded of William Bernstein's prediction: "very few of [the HBPP's] new fans will have the long-term discipline to stick with it when two of its riskiest and least conventional components, long Treasuries and gold, underperform, as they inevitably must..." (http://www.amazon.com/review/R20DI5V8YWKGZN/). From 1984 to 2001 the 60/40 portfolio's 10-year CAGR averaged over 13%, compared with 8.8% for the HBPP, with only slightly higher average volatility. In such a scenario, the HBPP would still not be broken, but it might be considered sub-optimal.

[AdamA]

But I wonder whether the model might be temporarily broken, until the Fed backs out of QE.

Why is QE bad for the PP?

[Stunt]

But I wonder whether the model might be temporarily broken, until the Fed backs out of QE.

Why is QE bad for the PP?

QE isn't "bad" for PP but the model is based on diversifying for each economic cycle and QE prevented these cycles from occurring as they would in the past. Risk on assets have benefited which is precisely what the PP sells short to reduce volatility. We all know that long term stocks have the highest average returns (actually small cap stocks) but those who subscribe to the PP sell some of that prosperity upside for more stable real returns over time. I think once QE is done or if QE did not exist, each component would move cyclically rather than all together with diminished returns like an asset bubble.

[Kshartle]

I think the economy has been getting ruined by all the government intervention and wars since the Clinton era, as well as the bursting of the Greenspan bubble. That's hurt business profits and stocks. The QE has added to long bond gains and kept the prices from falling but yields are now so low you won't get much there. The QE enables the government to borrow much cheaper than otherwise and adds to the deficits. This is really bad for the economy. Bridges to nowhere and paying people to either not work or create agencies to interfere with businesses is just a terrible waste.

There are people here who think QE doesn't do much. Needless to say I disagree. It's a blank check for the government to spend another 85 BN a month without having to tax or legitimately borrow. I know I know....we need the government to spend slips of paper to grease the economic wheels. I forgot I live in a Keynsian fantasy.

The saving grace for the past 12-13 years has been gold but the smackdown the past 18 months or so has been brutal. This is what I expect to reverse with a vengence but we'll see.

I don't see how the PP can return big gains in this environment with 50% in bonds yielding very little and stocks concentrated in the US at these prices (17-18 P/E now). Yes the S&P gets 40% of it's rev from overseas I think but The Americans and Europeans are looking like deadbeat customers.

[rutabaga]

Stocks + 15%
Bonds  + 15%
Cash    + 2%
Gold      -15%

The economy will remain approximately as strong as it is now.

[goodasgold]

Welcome aboard, stockscience. And let's hope your prediction comes true. A 2% cash return would be especially timely in this age of suppressed interest income.