What would make you abandon the PP?

[flyingpylon]

Seems like getting started with an investment strategy is always easier than giving up on one. I realize that great resilience is built into the PP, but sometimes things can change to a point where long-held assumptions and beliefs simply don't make sense anymore.

What conditions or level of underperformance would cause you to reconsider your faith in the Permanent Portfolio?

[Gumby]

Duplicate topic?

http://gyroscopicinvesting.com/forum/ht ... ic.php?t=7

[moda0306]

A gold standard, or Austrian (economic-theory... not the Governator) in the white house or fed chairman.

The PP is set up for a fiat currency.

[Roy]

A strongly-worded personal letter to me from John Bogle.

[moda0306]

3% fixed rate I-bonds.

[flyingpylon]

Duplicate topic?

http://gyroscopicinvesting.com/forum/ht ... ic.php?t=7

Thanks for the link... those are the kind of responses I was looking for.  I did a search before posting, but didn't find that thread.

[Lone Wolf]

A withering drawdown of >25% that lasted for a period of many months would have me really looking things over.  Before I jumped ship, I'd have to find some strategy that I believed would have PP-like characteristics and would be immune to whatever condition the PP hadn't been prepared for.  That's a really tall order.

http://gyroscopicinvesting.com/forum/ht ... ic.php?t=7

I agree with MediumTex's assertion at the end of the linked thread that a stock bull market is what's really going to test current PP adherents.  I imagine that during that time the portfolio will decline in popularity even as it continues to do what it's always promised -- deliver safe, steady returns without huge swings in value.

The trouble is that during a stock market bull run, it's easy to forget about safe, steady returns and think only of the triple-bagger biotech stock your neighbor was boasting about at the 4th of July barbecue.  I think that after several years this kind of thing might really wear at a person's patience.

My view on this biotech-loving neighbor is "good for him!"  My neighbor's being rewarded for taking on a level of risk that I no longer have any interest in.  He owns the risks and he owns the rewards.  I'll just take my "boring" returns and enjoy the booming economy!

If there is ever a time when I want my investments to underperform the broader market, it's when times are good, jobs are plentiful, and my salary is climbing in real terms.  Whether we wish to be or not, we're all a lot more invested in prosperity than that mere 25% investment in stocks.

[moda0306]

LW,

Be honest... if your "biotech neighbor" is kind of a douche, you kinda want his stock to tank, right?

Only after being asked at a poker party back in April, I said I thought LTT's were a solid bet, and that I thought stocks were overpriced given the bond yields and risks in Europe.  You think people hate the "biotech neighbor?"  Try pushing treasury bonds at a poker party!  It's like trying to teach religion at a wh0re house.

[MediumTex]

If there is ever a time when I want my investments to underperform the broader market, it's when times are good, jobs are plentiful, and my salary is climbing in real terms.  Whether we wish to be or not, we're all a lot more invested in prosperity than that mere 25% investment in stocks.

This is an incredibly important point.

The best time for investment underperformance is when everything else in your economic life is going well.

[moda0306]

MT & LW... another way to look at it....

When you're 25, by far the largest "asset" in your portfolio is your ability to use your skills to work for pay.

That asset's value has a high correlation to the stock market.

That asset continues to be the largest part of your portfolio for many, many years to come.  Most people don't save enough by the end of their careers to deliver them the same income they were getting by working in their productive years.

[Ad Orientem]

If one or more of the underpinnings of the PP were to disappear or be seriously questioned I might have to at least consider altering my portfolio.  I think someone mentioned here or on the related thread a return to a hard money system. That would certainly be one example.  Another might be an SHTF scenario.  If inflation reaches the point where the integrity of the currency is in doubt it would not make much sense to be rebalancing gold into bonds and cash.  But in general it would take something fairly serious to move me to abandon the PP.

That said I think a word might be in order about risk taking and investing in times of prosperity or even bad times.  There is absolutely nothing wrong with putting a little money on the line in a speculative investment as long as you are obeying the three cardinal rules.  If you think that we are heading into boom times, why not put a little money in your favorite stock or sector oriented ETF?  Or better yet buy some more VTI (or VEU)!  Just remember it's not part of your PP. 

Right now I don't have a VP.  But that's not because I'm against speculative investing.  I'm not.  It's just that I haven't found a speculative investment that has me seeing flashing neon dollar signs.  Mentally I have told myself that I am comfortable with putting around 20% of my total portfolio in a VP if and when I find something that sets me on fire.

On a side note, one of the best (read profitable) speculative investments I have seen was pulled off by a family member who bought a boatload of Ford Motor Company ultra long term non callable bonds for pennies on the dollar during the height of the financial panic in '08.  I am still green with envy.

[Tortoise]

If long-term Treasury yields were to drop below 1%, I'd probably modify my PP's allocations.

Looking at yearly PP returns since 1972, the best-performing asset out of the four each year has returned an average of around 30% (median of 25%). So, roughly speaking, I'd say each of the three volatile assets in the PP needs to be capable of at least 30% potential upside for me to feel like it's powerful enough to carry the whole portfolio if necessary.

Of the PP's three volatile assets--stocks, LTTs, and gold--the only one whose maximum potential upside can be calculated mathematically is LTTs. When LTT yields drop to 1%, the maximum potential upside (assuming yields stay positive) is about 30%, depending on the exact coupon rate and time to maturity.

As MT suggested in a different thread when we discussed this, if LTT yields drop that low, that may indicate a need to start converting some of one's LTT holdings into cash or short-term Treasuries. Above that 1% yield threshold, though, I'd say their upside potential justifies keeping them at the PP's full 25% allocation.

[MediumTex]

30 years of the classic 4x25 PP lagging short dated treasury's (as it did 1980 to 2009 inclusive)

That would have been bad timing.

Here is what would have happened after an investor bailed at the end of 2009:

2010:

ST Treasuries - 2.3%
PP - 14.5%

2011:

ST Treasuries - 1.39%
PP - 11.36%

[Ad Orientem]

30 years of the classic 4x25 PP lagging short dated treasury's (as it did 1980 to 2009 inclusive)

That would have been bad timing.

Here is what would have happened after an investor bailed at the end of 2009:

2010:

ST Treasuries - 2.3%
PP - 14.5%

2011:

ST Treasuries - 1.39%
PP - 11.36%

So the 65 year old that retired in 1980 and invested in a PP could at last, 32 years later aged 97, finally see that PP for the first time overtake STT's - by a 0.64% higher annualised over those 32 years. Here's hoping their Yeehaw doesn't lead to a cardiac arrest. Still a ways to go however to catch that smirky guy in the corner who read Ben Graham and invested 50-50 in total stocks and total bonds and who has nearly twice as much now, despite having started with a similar amount originally invested.

Hi Clive.  Good to see you back.  Do you think a 50/50 TSM-TBM portfolio is superior to an HBPP?  For the record I don't think it's a bad portfolio arrangement.  But it does leave one rather exposed in the event of a serious currency crisis.

[MediumTex]

30 years of the classic 4x25 PP lagging short dated treasury's (as it did 1980 to 2009 inclusive)

That would have been bad timing.

Here is what would have happened after an investor bailed at the end of 2009:

2010:

ST Treasuries - 2.3%
PP - 14.5%

2011:

ST Treasuries - 1.39%
PP - 11.36%

So the 65 year old that retired in 1980 and invested in a PP could at last, 32 years later aged 97, finally see that PP for the first time overtake STT's - by a 0.64% higher annualised over those 32 years. Here's hoping their Yeehaw doesn't lead to a cardiac arrest. Still a ways to go however to catch that smirky guy in the corner who read Ben Graham and invested 50-50 in total stocks and total bonds and who has nearly twice as much now, despite having started with a similar amount originally invested.

Yeah, but the 65 year old who retired in 1972 sure would have appreciated the PP.

The PP is a conservative investment strategy.  The fact that it had an extended period where it didn't outperform ST treasuries isn't a cause for alarm to me, though it might be for some.

I think that recent years have demonstrated that simply buying ST treasuries would not have been a better strategy than the PP.

[Gumby]

So the 65 year old that retired in 1980 and invested in a PP could at last, 32 years later aged 97, finally see that PP for the first time overtake STT's - by a 0.64% higher annualised over those 32 years. Here's hoping their Yeehaw doesn't lead to a cardiac arrest. Still a ways to go however to catch that smirky guy in the corner who read Ben Graham and invested 50-50 in total stocks and total bonds and who has nearly twice as much now, despite having started with a similar amount originally invested.

Poor 95 year old retired guy with a 7.89% annual return from 1980-2009 (4.13% real)

[moda0306]

Clive,

ST treasuries were a phenominal investment, risk-adjusted, during the time-period you mentioned.  I don't think anyone who tried to invest safely during that period would have much to complain about getting those returns.  The treasury was being punished for decades for inflation that people expected to see but never did.  People got to ride the safest asset in the world for a solid real return and almost no volatility.

However, a Ben Graham investor would probably not be too pleased with his 1970-1980 or 2000-2011 returns compared to a PP investor.

Further, with 50% stocks in stocks (as opposed to 25%), and considering the 50% bond portion likely is short on Long-dated treasury instruments and includes non-treasury and callable bonds (I haven't found anything saying he suggests otherwise), a Ben Graham investor would have ben slapped silly in 2008, and during other smaller economic shocks.  I am sure an old man would have slept fine avoiding these worrisome events.

Lastly, you've recognized the PP for having incomplete hyperinflation protection, as balancing out of gold into other assets during a hyperinflation will leave you battered.  How does Ben Graham's portfolio help you fight inflation?  You've also pointed out that the PP (though not out of a gold standard yet) may have had a rough period around the great depression.  How would Ben Graham's porfolio have come out of the stock market dropping 90% in value?  I'm not saying loading up on more stocks and bonds outside of the PP is inappropriate, but it'll eventually fail in the way it'd be difficult to imagine the PP failing, and a 20%+ drop in value in 1 year isn't at all hard to imagine.  Ben Graham's follower won't be smirking at the end of that year.

[MachineGhost]

So the 65 year old that retired in 1980 and invested in a PP could at last, 32 years later aged 97, finally see that PP for the first time overtake STT's - by a 0.64% higher annualised over those 32 years. Here's hoping their Yeehaw doesn't lead to a cardiac arrest. Still a ways to go however to catch that smirky guy in the corner who read Ben Graham and invested 50-50 in total stocks and total bonds and who has nearly twice as much now, despite having started with a similar amount originally invested.

What about 50 ST, 50 Gold?

And what about some foreign stock exposure to the PP, would that have beat ST only since 1980?

MG

[cowboyhat]

I think there are really three questions to ask yourself when you consider "What would make you abandon the PP?"

1) The first question is the one that Medium Tex answered: "When are you likely to abandon the PP?" His answer, based on the historical record, is when returns from the PP feel like losses. Humans don't think about gains and losses in absolute terms, they think about them relative to a benchmark. For investing the benchmark is something like a 60/40 stock/bond portfolio. If you are like most people, and the truth is (if you can stand the truth), we are all like most people, you'll bail on the PP in the next market boom. Then your stock heavy portfolio will get trashed when you fail to time the inevitable bust.

2) The second question is "When should you really consider bailing on the PP?" The answer is when the economic assumptions underlying the portfolio are no longer valid. There could be a change in the monetary system, for example although unlikely, back to gold. This would require a rethink. Perhaps more likely is that one of the 4 elements of the PP may reach a price where it has essentially zero expected value: LT Bonds at 1%, stock market PE > 30, someone finds a mountain of gold in the Australian outback, President Clinton appears on TV and says that her administration will never ever devalue the dollar.

3) The third question is "What is really wrong with the PP?"  I think Clive has identified the two most serious problems. The first is the problem of the strategy leading you to repeatedly double down into an asset in a death spiral. The second is that the PP is a low volatility-low return strategy. There is no free lunch. If you are counting on a high return you are going to be unhappy.

[moda0306]

cowboyhat,

I partially disagree with both of your assertions in the 3rd point.

1) A "death spiral" of the dollar would essentially mean that the dollar is no longer really even the "domestic currency" in any legitimate use of the term... It's relatively easy to pick a certain inflation percentage (1,000% per year? (I'd pick something lower)) where you start to question whether your government's currency is even truly "the domestic currency" anymore, due to what appears to be a complete rejection of it.

2) The PP, so far is a low-risk moderate-return strategy.  To call 9.5% return "low-return" is excessive.  Even its weaker return since 1980 is hardly "low."  I think the PP has about the best risk-adjusted returns out there, and to be honest if I wanted to build a riskier, but better portfolio, I'd probably simply remove some cash and some gold, add some stocks and call it a day.   I'm not particularly bullish on stocks going forward, and I could envision both gold: $2,500 and bonds: 2.5% in the not-too-distant future, so I don't really see many really attractive options out there far outside of what the PP offers.