Gyroscopic Investing

I will be 27 next month, and am fairly optimistic about the long term outlook for the stock market. The standard advice of age in bonds makes sense to me, but would I add some safety and stability by instead choosing to do age in PP?
For example, next year:
27% PP (or PRPFX)
73%: Balanced/aggressive VP consisting of mainly growth mutual funds.

Every year, I would move 1% of my portfolio from the VP to the PP. Once I hit retirement, I would probably convert everything over to the PP.

Honestly, volatility at this point doesn't bother me. I actually get happier when the stock market goes lower or crashes, because it seems like a great time to buy! I like to think long term and would never pull my money out and convert it to cash.  But as I get closer to retirement, I am sure my anxiety would increase a bit.

Crazy idea or no?

Whatever you decide, try to come up with a strategy you can stick with.

What you are describing doesn't sound like a strategy that most people would stick with for more than a few years.

Why not just age in safety assets? So when you are 30 you would have 70% stocks, 10% Gold, 10% LTT, 10% cash.

For what its worth I am 20 and the financial media eggs me to take on risk too.

However, I am perfectly happy with all of my money in the traditional PP. I am not convinced that adding time to the equation reduces risk. Why should it? Also, the amount of time where your wealth has reached critical mass is surprisingly short. Having a conservative portfolio already in place means that you are less likely to lose it when it really counts.

MediumTex wrote: Whatever you decide, try to come up with a strategy you can stick with.

What you are describing doesn't sound like a strategy that most people would stick with for more than a few years.

What would be the reasoning be for not sticking with it?

beafet wrote:

MediumTex wrote: Whatever you decide, try to come up with a strategy you can stick with.

What you are describing doesn't sound like a strategy that most people would stick with for more than a few years.

What would be the reasoning be for not sticking with it?

The same thing that makes people not want to stick with almost anything in life.  They get bored, frustrated, greedy, disillusioned, etc.

Most people spend much of their investing careers bouncing from one strategy to another, looking for the holy grail as they underperform more conservative portfolios.

If what you are proposing works for you, then do it.  It just sounds to me like a strategy that would be tempting to abandon if the stock market either got very good or very bad.  The appealing thing about the basic PP, to me, is that its success doesn't depend upon any particular market conditions.  The strategy you propose, OTOH, in the midst of a secular bear market for stocks that could easily last another 5-10 years sounds to me like something that could lead to much future regret.

If volatility doesn't bother you at all, and you in fact actually like it, then why not go 100% stocks?

clacy wrote: If volatility doesn't bother you at all, and you in fact actually like it, then why not go 100% stocks?

Most people greatly underestimate their ability to stomach volatility.  This is the main reason people lose money investing. 

Keep that in mind as you make this decision.

Also keep in mind that the more you have saved, the harder the volatility is to take.

I guess your reasoning is that you think that long term the stock market will out perform the PP? It wouldn't amaze me that if someone had  100% US stocks in 1999 or 100% Japanese stocks in 1989, then they might never catch up with the PP even over >50 years. If you like financial risk then IMO there are good ways to play that. You could be 90% PP and 10% venture capital. Then at least if you loose on your "risk", you will have created jobs etc. If you win, then you could win a lot and help to create a transformative technology or something like that. IMO a 100% stock portfolio is simply opening your pockets to be picked by Wall Street.

beafet wrote:I will be 27 next month, and am fairly optimistic about the long term outlook for the stock market.

I'm impressed at your optimism. How did you come to that conclusion? My Magic 8 Ball is predicting a very different outcome...

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beafet wrote: I will be 27 next month, and am fairly optimistic about the long term outlook for the stock market. The standard advice of age in bonds makes sense to me, but would I add some safety and stability by instead choosing to do age in PP?
...
Honestly, volatility at this point doesn't bother me. I actually get happier when the stock market goes lower or crashes, because it seems like a great time to buy! I like to think long term and would never pull my money out and convert it to cash.  But as I get closer to retirement, I am sure my anxiety would increase a bit.

Regardless of what approach you choose, I wish you great success.  Let me just give you a bit of perspective on how I came to embrace conservative investing.

It sounds like you were 23 at the time the market crashed.  I'll be a little presumptuous and project my 23-year-old self into that time period.

When I was 23, I had very little money and would have easily shrugged off something like the '08 crash.  The only thing I'd have been worried about was my job.

Fast forward to when I was 30, the actual age when I experienced the 2008 crash.  I'm married, starting a family and have many years of careful saving under my belt.  2008 left me watching much of what I (and my wife!) had saved go up in smoke.  This was not a pleasant experience.  Losing money sucks, especially when you realize that you have no guarantee that it will "bounce back" any time soon.

I recovered my losses by pouring cash into the market when I perceived it to be "cheap", but in retrospect this was nothing more than a risky gamble that paid off.  Japan's stock market has been grinding sideways and downwards for 25 years!  What if I'd been buying into that?

The trick with something as volatile as the stock market is that these positions can be difficult to exit.  For example, if in 3-5 years you find that you have lost your appetite for risk (as I lost mine), you will need to sell a great deal of your stock market holdings to convert to a PP.  If your holdings happen to be down a lot, this sale could be very painful.

Just something to consider.  Good fortune to you regardless of how you choose to go.

stone wrote: I guess your reasoning is that you think that long term the stock market will out perform the PP? It wouldn't amaze me that if someone had  100% US stocks in 1999 or 100% Japanese stocks in 1989, then they might never catch up with the PP even over >50 years. If you like financial risk then IMO there are good ways to play that. You could be 90% PP and 10% venture capital. Then at least if you loose on your "risk", you will have created jobs etc. If you win, then you could win a lot and help to create a transformative technology or something like that. IMO a 100% stock portfolio is simply opening your pockets to be picked by Wall Street.

Yeah, long term (35-40 years) I expect the stock market to get me better returns than the PP. And I wouldn't be 100% in the stock market, I would be closer to 82% in the stock market at worst, and that would go lower every year.

I suppose I am not a typical 27 year old... I was married, had and bought my first house before I was 21.  Now we are finally making money with our rental house, I have 3 daughters and have a stable job in the military. I barely make any money now, but am developing the skills, knowledge, and experience to have a great paying job whenever I get out. I had a small amount of mutual funds that took a beating, but of course my income was a much greater concern as you suggested. Right now it still is. Your income is your biggest wealth building asset. So, once we get our tax return, we will be able to pay off our final debts (except our house), and start seriously investing. I feel like I am playing serious catch up though, since I have wanted to be preparing for retirement nearly ten years ago...

Beafet, have you seen Gumby's chart of inflation adjusted PP versus SP500 returns 1972-2011? That chart makes it look as though the 1999 bubble was just a transient poking through of the PP level of returns. Best of luck though.

beafet wrote:
Yeah, long term (35-40 years) I expect the stock market to get me better returns than the PP. And I wouldn't be 100% in the stock market, I would be closer to 82% in the stock market at worst, and that would go lower every year.

Like MT says, you have to be comfortable with whatever strategy you chose.

Think long and hard about this though.  The PP gets very good returns...consistently.  You are basically gambling with a stock heavy portfolio.  Search "Japan" on this website and you will see what can happen to stocks for VERY long periods of time (decades) after a credit bubble bursts (like what happened in 2007).

27-year-old Beafet might be doing 47-year-old Beafet a big favor by sticking to the PP.

beafet, I'm just curious: wouldn't you be more excited if the stock market surged so that you could sell more of your VP into non-stock assets?

beafet,

What makes you optimistic about the stock market? 

Have you read up on what's going on in Europe right now?  A lot of smart people on both sides think the Eurozone is effed.  This would be pretty bearish for US stocks, which are very exposed to foreign markets as-is.

I'm not trying to lecture... just don't want you going in with the same assumptions I did when I bought a rental home in 2003, and learn the hard way how macroeconomics & deleveraging works.

That said, at sub-2% 10-year treasury rates, it makes what would be relatively unattractive stock p/e ratios look pretty darn good at times.

As a speculative play, in this environment with the Euro being such a mess, I only make VP moves into stocks when the dividend yield of the S&P moves above the 10-year treasury rate.  Today we're about at that point.  This is just fun-money though... I don't use much money to do this, nor do I keep it in stocks long after they recover and bond rates go back up to low-to-mid 2% rates (I benchmark with the 10 year... though I buy 20-30)

Adam1226 wrote:
27-year-old Beafet might be doing 47-year-old Beafet a big favor by sticking to the PP.

41 year old MediumTex has periodic discussions with 21 year old MediumTex.  We enjoy covering some of the hard lessons that have been learned along the way.

41 year old MediumTex also listens for any subtle messages that 61 year old MediumTex may be sending through time.  While the signal is normally very faint, the theme of these messages is normally something like: "A lot of stuff is going to happen that will be very surprising to most people.  Be careful."

If I could go back and give my 27-year-old self some advice it would be to ban the word "optimism" from my investment vocabulary.

jackh wrote: If I could go back and give my 27-year-old self some advice it would be to ban the word "optimism" from my investment vocabulary.

I would like to try to slice this sentiment a little more finely.

I think that many investors today suffer from what is basically a delusional optimism about the future.  This delusional optimism can be explained by the "recency bias" of having seen in our lifetimes very impressive returns from optimism-based investments like stocks.  In other words, it's no surprise that the delusion du jour is tilted toward optimism; I'm sure that in the 1930s there was a similar form of delusional pessimism that took a long time to be completely purged from the system.

I think that the value in identifying this delusional optimism that permeates so much of the investing world right now (even after the carnage of recent years) is that it helps us to understand what we need as individual investors to achieve a balanced perspective on things.  For most investors, I think what is needed is a good dose of humility and skepticism to offset the natural tendency toward unwarranted optimism (I think the Zero Hedge crowd calls this form of optimism "hopium").

One of the nice things about the PP is that it essentially force feeds you a balanced diet of optimism (stocks), skepticism (gold), caution (cash) and humility (long term treasuries).

stone wrote: Beafet, have you seen Gumby's chart of inflation adjusted PP versus SP500 returns 1972-2011? That chart makes it look as though the 1999 bubble was just a transient poking through of the PP level of returns. Best of luck though.

Here it is:

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Stocks tend to beat the Permanent Portfolio is if you accumulate stocks at the right time and you reinvest every dividend back into your stocks, as shown in this chart. Since stocks are more volatile, your performance is greatly tied to when you begin and end your investments.

See: The One Missing Investing Ingredient: Luck

In other words, if I started the chart at any other point in time, the results for stocks would look very different.

The reason we all prefer the PP is because its low volatility virtually eliminates the issue of buying at the wrong time. I think to fully embrace the PP, you will need to admit to yourself that stocks could go down — in "real" terms — for another 10 years, or more.

Stocks don't have to go up.

To add to what Gumby said, people who believe in such things are saying that currently the stock market is not in an undervalued state such as would provide a buying oppertunity. One such way to value the stock market is the Q ratio:

http://en.wikipedia.org/wiki/Tobin's_q
Another use for q is to determine the valuation of the whole market in ratio to the aggregate corporate assets.

Another is the Shiller CAPE

Neither of those measures suggest that now is one of those windows of oppertunity for stocks. Personally I don't trust market timing and so like the PP. I guess an arch market timing enthusiast could be in the PP and then move to a stock overweight position if and when the Q and/or the CAPE looked like 1982 was happening again.

stone wrote: I guess an arch market timing enthusiast could be in the PP and then move to a stock overweight position if and when the Q and/or the CAPE looked like 1982 was happening again.

Such a market timing enthusiast could have also picked up some 14% 30 year bonds in the early 1980s and some $250 gold in the late 1990s.

Obviously, this is all harder than it looks.

Has there ever been a 40 year period with negative returns for the stock market?

beafet wrote: Has there ever been a 40 year period with negative returns for the stock market?

If you didn't reinvest all of your dividends, the answer is yes:

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The chart shows that you would have lost money, in real terms, if you had started investing circa 1906 or in 1929, and didn't reinvest your dividends. And for all we know, 2011 might also be one of those times where stocks go down for 40 or 50 years.

But, let's face reality here... Almost no one would have been able to stomach holding their stock portfolio between circa 1906 to 1946, or 1929 to 1986. If people were actually like that, we wouldn't be having this conversation.

The reality is that most people would have sold their stocks at the worst possible time.

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Keep in mind that the point of the Permanent Portfolio is not to beat the market. The point of the Permanent Portfolio is to prevent this fear/optimism curve from happening.

We sacrifice a higher return for stability. The idea is that we are more likely to stick with the Permanent Portfolio than a portfolio with higher volatility. It's the Tortoise and the Hare.

As Harry Browne once said (skip to 23m 45sec):

CALLER: [PRPFX] has done extremely well over the life of the fund, has it not?

HARRY BROWNE: Yes. Now there are going to be other funds that have a higher yearly return over a long period. But, they get that return with what I keep referring to as the 'roller coaster ride.' You have these wide swings where you're up one year by 30% and then the next year you're down 15%, and so on. Whereas if you could look at a graph of the Permanent Portfolio Fund or the kind of personal Permanent Portfolio that I recommend, what you'd see is just steady growth year after year, after year, of a more modest amount. In the case of the personal Permanent Portfolio that has gained 9% a year, over the last 30 years, and the Fund return has been similar with no big losing years at any time. So it's much easier to stay with that kind of a program, 'cos you don't get into a period like 2000 or 2002 when the stock market is falling and your favorite mutual fund is doing badly and you think, 'Gosh, I gotta abandon this,' and do something else and you drop out of it right at the bottom as it starts to go back up again.

CALLER: [chuckling] That's kind of what I do with the Stock Market, as a fatter of fact!

HARRY BROWNE: Well, it's not the least bit unusual. And that's why stability is just as important as performance. Because a lack of stability can cause you to be anxious about it all the time. And secondly, to make poor decisions because the swings in the market affect you, and you can only ride it down so far, so you finally get out of it. And you may get out of it halfway down or you may get out of it right at the bottom.

You would need nerves of steel to survive the roller coaster ride that Browne describes, above.

Over the last 20 years, the Nikkei in Japan has lost over 75% of its value.

Over the next 20 years, the Nikkei would need to quadruple in value just to get back to 1990 levels.

I think that Japan is well on its way to a 40 year period of negative returns.

From a demograpic perspective, Japan is about 10 years ahead of the U.S., so it is reasonable to be concerned that the same headwinds that the Japanese market has encountered over the last 20 years (i.e., a once in a generation deleveraging period accompanied by unfavorable demographics) could provide similar headwinds to the U.S. market for many years, and we may actually be in the early stages of a market environment that could persist for a very long time.

None of this is set in stone, of course, but I rarely see this facet of market risk discussed by the financial media.

MT,

And when it is, they immediately rush to the fact that the Japanese are/were savers, but our debt is owned by other countries, as if that's supposed to make a deleveraging here less, not more, deflationary and disastrous to our balance sheets.