Permanent Portfolio - Does it do more than preserve Purchasing Power?

[Austen Heller]

Does the PP do more than just preserve purchasing power?  For instance, I graphed the Year-To-Date performances for VTI (stocks), TLT (bonds), Gold, and SHV (cash), and the Total PP (see graph below).  You can see that the Total PP has a return of 8.2% so far this year, if you had started the 2010 year with all 4 components balanced at 25% each.  So my question is: For someone who put all their money in the PP at the start of the year, does that person actually have an increase in purchasing power now?  Or has the purchasing power remained nearly constant, and the 8.2% gain merely reflects a stealth decrease in the value of the dollar, such that the investor's purchasing power has remained constant.  This would be consistent with a model in which the US govt is understating actual inflation levels via the CPI (we know this has to be partly true since the cost of healthcare spirals ever higher, and the size of cereal and ice cream containers seem to be getting smaller).

I know that the Year-to-date data covers a fairly short time period.  However, the question can be extrapolated to any longer time period in which the PP outperforms gov't issued CPI data: Has the PP merely preserved purchasing power, even if the PP gains are very high (such as right now)?

[Pkg Man]

CPI inflation as measured by the Bureau of Labor Statistics is less than 0.2% YTD, and 1.4% compared to last year.  Even if you believe the government is grossly miscalculating inflation it wouldn't come anywhere near 8%.  Health care costs are included in the CPI and they also adjust for quantity as well as quality.  The latter is where some folks have an issue with how the CPI is measured. 

Of course the 0.2% figure is only for a representative basket of goods.  It will not apply to every individual the same way.

So I think the answer is no, the PP has historically provided a real return of about 5%, although the last few years I think is has averaged quite a bit less than that.

[craigr]

For US investors the portfolio has a real return averaging in the 3-5% over the past 40 years. So yes, the portfolio does more than just preserve purchasing power. It actually does grow money faster than inflation.

[Austen Heller]

Thanks for the replies.  It is very interesting that the consensus is that the PP does increase wealth at a rate faster than inflation.  I hope that this trend continues going forward (but I must say I am somewhat unsure with bond prices and gold near the top of their historical ranges).

For me, rather than go "all-in" with the PP, I have elected to start slow.  I partitioned my assets such that stocks, bonds and metals are purchased using retirement accounts, leaving my taxable accounts in cash instruments (money markets, CDs, I-Bonds, short-term treasuries).  This results in a final PP allocation of about 12/12/12/64 (stock/bond/gold/cash).  I did this for two reasons: 1) I did a lot of trading in 2009 in taxable accounts, and I got stuck with a hefty tax bill at the year end.  It made me feel like I only wanted to buy risky assets using tax-free accounts. 2) The large cash allocation allows to me to get used to the PP concept, without too much risk.  I have a history of starting with new allocations and then bailing out when times get tough, so I'm hoping that "this time is different" with the PP.  My biggest risk right now is that the PP will significantly outperform my cash, but that is acceptable.

When taxes and costs are also considered, the PP has greater potential to be lower cost overall.  For example in the UK gold Sovereign coins, being 'legal tender', are purchase and capital gains tax exempt, cash (1 to 5 year gilt ladder) and long dated treasuries can be invested through ISA's and provide gains both exempt from capital gains tax and income tax.  Yearly capital gains exemption allowances (currently around $15,000 per annum) can be used to sell/re-buy shares in order to mitigate capital gains tax.

I had no idea that the UK was so tax-friendly.  I thought those European countries taxed the heck out of their citizens to pay for all those social programs.  Tax exemption for gold coins and a $15k tax exemption on cap gains would be great in the US.

[Austen Heller]

We do however pay (soon rising to) 20% purchase tax on non essentials (VAT).  After about the first $10K of earnings, that's tax free, income tax will also take around a quarter of additional earnings, and that rises to 40% for earnings over around $70K. There's also the 6% of earnings national insurance (medical) to be paid.

I guess there is no free lunch.  The UK income tax rates seem similar to US rates (at least in a high-tax state like California), but that extra 20% VAT is a killer.  I have heard of VAT proposed in the US, and I recently watched an interview with Rep. Paul Ryan of Wisconsin who advocated a VAT to possibly replace our current income tax system......but to throw a large VAT on top of the income tax just seems like regressive overtaxation to me - although any solution to the current mess will seem quite unpalatable at first.

With gold from a UK investors perspective its a bit difficult to know whether to go for physical or paper versions.  If we buy IAU in an ISA account for example we might pay only 0.25% yearly expense ratio, whilst gold sovereign coins typically have a 5% to 10% bid/ask spread.  For physical gold therefore its quite a high up front fee (20 years of IAU's ER).

The 5% spread is about right, but a 10% spread would be ridiculous.  I've seen spreads in the US of about $50-60 per ounce, which is currently about a 4-5% spread.  Before the IAU expense ratio change, all the gold ETFs were at around 0.4% per year, which made the cost of obtaining physical metal about 10 years worth of ETF expenses.  After the IAU change, it's now much longer, but I know what the PP purists would say.  Even if the ETF expense ratios were dropped to 0%, they are still a bad deal since you don't possess the gold.  The best strategy I have heard is to own mostly physical metal that you hold yourself, but also hold about 10-20% of your total allocation as an ETF (in a retirement account) for rebalancing purposes.