Gyroscopic Investing

I was thinking about the overall construction of the Permanent Portfolio and how it relates to the value of your local currency.  Since the PP is designed to be agnostic towards the future, does it not make sense to design the portfolio so that it balances the potential increase and decrease of the value of your currency?

Here is a crazy idea which I like to call the '50/50 option' (patent pending).

What you do is place 50% of your assets in your local currency, and then the other 50% outside of the local currency.  Here is an example:

Local Currency:
- 20% Short term bonds
- 15% Long term bonds
- 15% Local Stock market
Total =50%

World/Other Currency:
- 25% Gold
- 5% World Short term bonds
- 10% World Long term bonds
- 10% World stock market
Total = 50%

For a Canadian PP (or other 'smaller' country) this option might make sense.

Is there an advantage to placing 75% of your assets in your local currency?  I realize the standard advise is to place the majority of your assets in the currency you plan to use during retirement, but is this another one of those silly rules that everyone just accepts?

This is a little more complex and doesn't have the same ring as 4x25, but I kinda like it.

I might play around with some back-testing tomorrow (unless someone else wants to do it for me ).  I have a feeling it won't make a big difference, but might help support the foundation of the Permanent Portfolio.

That's all for now. TGIF!!!

I've often thought about diversifying my PP to include a certain % of foreign exposure. 

The thing is, I think it's kind of a guess as to what "other" currency you'd use.  

I consider gold to be the PP's alternative currency.  

I think Clive once posted stuff about a blend of US, UK and Japanese PP doing slightly better than either one did individually. The thing is, volatility against your own currency is the volatility that hurts. Imagine a Japanese person living in Japan had held a UK PP in 2008; I guess they would have seen something like a 50% loss in JPY terms or in terms of how much rent, trainfares, medical bills etc, etc cost. Knowing that they were slightly up in GBP terms would have been scant consolation.

I agree with Adam that gold acts to provide exposure to the global economy.

More currency diversification makes sense to me, especially if you want to spend some time and money outside the US in retirement, or just ensure the option stays open.  Gold is 25% already.  If you use VT for the equity holding it is less than 50% US, so you have 37.5%+ in non-dollar assets. 

For me that's enough.

Test driving the 50/50 Option:

                              50/50 Option Canadian PP           Standard 4x25 Canadian PP
3 month T-bills (CAD).............17.5%...............................25%
Long Canadian Bonds..............17.5%...............................25%
US Bonds.............................15%..................................0%
TSX Composite......................15%..................................25%
S&P500................................5% ..................................0%
MSCI EAFE............................5%...................................0%
Gold Bullion...........................25%..................................25%

Re-balanced annually.

Average Gain (Geometric)......10.04%.........................10.01%
Average Gain (Arithmetic).......10.33%............................10.31%
Median Annual Gain...............8.34%..............................9.78%
Standard Deviation................8.20%.............................8.54%
Total Growth (%) ................4959%.............................4890%
Total Value of a $1000..........$50,586.12 ......................$49,896.91
Total Down Years.................1 years (2%).....................1 years (2%)
Total Years < 5.00%.............9 years (22%)...................9 years (22%)
Total Years < 10.00%...........24 years (59%)..................22 years (54%)
Total Time Span...................41 years...........................41 years

Nominal Gains
        50/50        4x25
1971 11.91% 10.40%
1972 21.14% 21.27%
1973 16.79% 18.65%
1974 13.06% 12.22%
1975 5.39% 3.05%
1976 10.00% 9.78%
1977 15.74% 15.18%
1978 23.35% 22.70%
1979 39.89% 44.23%
1980 15.40% 15.85%
1981 -6.15% -6.53%
1982 23.53% 21.55%
1983 8.29% 9.93%
1984 5.73% 2.97%
1985 23.46% 18.43%
1986 17.02% 13.87%
1987 7.00% 7.82%
1988 1.04% 2.43%
1989 10.59% 10.82%
1990 0.42% 0.50%
1991 10.02% 9.18%
1992 7.12% 5.15%
1993 20.18% 20.63%
1994 2.15% 0.37%
1995 12.12% 11.60%
1996 8.34% 10.80%
1997 6.77% 4.65%
1998 9.66% 5.55%
1999 4.24% 6.35%
2000 5.43% 6.02%
2001 2.83% 1.23%
2002 5.57% 6.40%
2003 5.30% 9.30%
2004 4.02% 6.02%
2005 9.74% 13.60%
2006 13.18% 12.22%
2007 3.71% 7.42%
2008 4.50% 0.17%
2009 7.64% 12.25%
2010 11.22% 13.22%
2011 6.04% 5.42%

Edit: Source http://www.ndir.com/cgi-bin/downside_adv.cgi

Place numbers into a pot, boil for 20 minutes, and here is what you get for the 50/50 Option:
- no improvement in overall return
- a decent improvement in standard deviation, but a little extra volatility doesn't bother me too much
- it did better in 2008, but worse in 2009

Conclusion: The 4x25 Canadian PP is perfectly fine, but if you want to spice things up and add some USD assets, then this can be done.  I would maintain at least 50% CAD, since a 100% US PP in CAD has a lower return (9.82%) and a much higher standard deviation (9.3%).  Another consideration is the cost to buy US assets, at 2-3% per transfer from CAD to USD, one must be careful.

Personally I use 5% XWD, and will likely add 5% TLT since I have some extra USD's that I'd rather not convert to CAD if I don't have to.  This puts me in the 65% CAD range and I am happy with that.

World/Other Currency:
- 25% Gold
- 5% World Short term bonds
- 10% World Long term bonds
- 10% World stock market
Total = 50%

What are the funds or ETFs that you use in this allocations?

escafandro wrote:

World/Other Currency:
- 25% Gold
- 5% World Short term bonds
- 10% World Long term bonds
- 10% World stock market
Total = 50%

What are the funds or ETFs that you use in this allocations?

I was trying to keep things generic in the OP, so I'm not sure what an American would use, but as a Canadian I would use US bonds and then a world stock index, here is an example:

- 25% Gold (GTU.UN or IGT)
- 5% World Short term bonds (SHY)
- 10% World Long term bonds (TLT)
- 10% World stock market (XWD)

Honestly, the '50/50 Option' is probably not necessary for a US PP since you guys and gals are dealing in the reserve currency.  But if someone was inclined to expand the PP beyond their borders, then I thought this might be a reasonable set-up.  In my mind it matched the PP philosophy of not predicting the future, so I thought I'd share it with the group to get their take.

Assumptions/Notes:
- Source for PP's based in CAD: http://www.ndir.com/cgi-bin/downside_adv.cgi
- The Long Bonds from above source contain provincial and corporate bonds, and the maturity dates are less than desirable (but its all I have)
- Source for US PP in USD: Simba
- Canadian CPI data from http://www40.statcan.ca/l01/cst01/econ46a-eng.htm
- I applied the Canadian CPI data to the US PP, because I'm too lazy to find the US data
- Rebalanced annually
- I simply used the excel STDEV and AVG to calculate the standard deviation and average real return
- 50/50 Portfolio balances CAD with Gold/foreign at 50/50 ratio
- 65/35 Portfolio balances CAD with Gold/foreign at 65/35 ratio
- This is very crude, but gives us a glimpse of what the Canadian PP can do


STANDARD DEVIATION (annual data averaged over five year intervals)

              CA PP     US PP (CAD)   50/50       65/35     US PP (USD)
2011-2007   5.9%         7.6%         3.4%      4.7%         7.3%
2006-2002   3.4%         6.9%         3.9%         3.5%      2.8%
2001-1997   2.4%         7.6%         3.2%         2.5%         4.6%
1996-1992   7.0%         5.1%         6.1%         6.3%         7.8%
1991-1987   4.1%         6.8%         4.4%         4.1%         4.7%
1986-1982   6.2%         10.4%       7.7%         6.6%         8.9%
1981-1977   19.3%         15.9%       17.8%       18.5%     16.9%
1976-1972   9.3%         5.6%         8.1%       8.7%       6.3%
TOTAL         8.4%         9.0%       8.0%         8.1%       7.9%


AVERAGE REAL RETURN (annual data averaged over five year intervals)

              CA PP     US PP (CAD)   50/50       65/35     US PP (USD)
2011-2007   5.9%         3.4%         4.8%         5.2%        7.8%
2006-2002   7.3%         0.5%         5.4%          6.3%         7.0%
2001-1997   2.8%         7.3%         3.8%         3.1%         3.2%
1996-1992   8.3%         9.9%          8.6%           8.2%          6.4%
1991-1987   1.4%         0.8%         1.1%         1.3%          2.9%
1986-1982   7.5%          12.4%        9.8%            8.2%          7.9%
1981-1977   8.5%         5.7%         7.9%         8.5%          3.5%
1976-1972   4.7%         5.4%         5.0%         4.8%          4.9%
TOTAL            5.9%         5.6%       5.8%            5.8%          5.4%

Observations:
- Adding 10-25% USD assets to the CA PP will help reduce volatility; however increasing USD to 75% will significantly harm CA PP during times of a strengthening CAD such as during 2001-2006.
- Returns from 1987-1991 would have likely been improved through a proper holding of Long Bonds.
- The volatility from 1977-1981 was caused by the peaking and crashing of gold, but the CA PP still returned 8.5% above inflation over this period

Conclusion:
- I'm not changing a thing.  I will stick with the 65/35 option and maintain 5% in XWD (contains 50% US stocks, 50% developed world stocks) and 5% TLT.

Gosso,

That's awesome!

Thanks for all your work and analysis.

I bet you that Crown Royal is tasting better all the time!   

bluedog wrote: Gosso,

That's awesome!

Thanks for all your work and analysis.

I bet you that Crown Royal is tasting better all the time!

Haha, I do love that Crown...just don't tell anyone I was sipping tequila while I was pulling those numbers together. 

I'm glad that analysis helped you.  I was mainly trying to calm my own fears on how the CA PP would respond to an appreciating and depreciating CAD.  By adding a little USD assets, it seems to help smooth things out.  So I now say good enough.

bswift wrote: More currency diversification makes sense to me, especially if you want to spend some time and money outside the US in retirement, or just ensure the option stays open.  Gold is 25% already.  If you use VT for the equity holding it is less than 50% US, so you have 37.5%+ in non-dollar assets.   

For me that's enough.

This is the big one for me. I can totally see leaving the US permanently at some point. Especially if a particular destination was a relative bargain. Just keeping that option open is important to me psychologically. If I was across the border to the North like Gosso I would definitely want to diversify out of the local currency. Of course if I were Canadian and owned a house in Vancouver I would just sell now and head for Argentina.

The only issue for me is that I'm already holding the world's reserve currency as my local currency. The idea that the US$ may have peaked as a reserve currency is part of the reason for more focus on Gold and Silver in my VP, but I may look at other international options now.