Gyroscopic Investing

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Clive,

You are so facile (in the good sense of the word ) with this stuff! A very interesting analysis and presentation. Thanks!

My question would be: couldn't the same outcome be accomplished by taking the currency risk with say, VWO, with the greater opportunity of "more bang for you buck" on the equity side at lower cost?

Maestro G

Clive wrote: If your income needs are met directly from income streams then capital value fluctuations become much less of a concern.

I've thought about this kind of thing too.  My one worry with the PP is that I'll agonize too much over deciding on a safe withdrawal rate.

Any reason you went with ELD over IGOV?

Another asset with income streams from diverse currencies is global REITs.

Clive you are one smart cookie.  I know this approach has been suggested in theory many times, and I suspected deep in my gut it would work but I could never be bothered to prove it up or think how it would be implemented.

I salute your resourcefulness in accomplishing what I could not. 

My original thought was to figure out what grab basket of currency specific ETFs (like FXY for the yen for example) would give the desired spread and weight to the theoretical grab basket of foreign currencies, and while I suppose that would work in theory, I've no idea how to calculate what percentage of each currency should be held within the currency "slice" of the portfolio.

This approach solves that problem very handedly and with the elegance of simplicity.  I may very well try to implement this approach in the future as it would simplify my holdings even more.  Essentially this is a three ETF PP.

Clive,

This is an interesting post, as was your relative strength PP post. Your observation that a Japanese PP didn't really work very well in the last decade made me reflect on Harry Browne's advice to focus on domestic investments.

Hypothetically, if this were 2005 and we were living in Iceland, what would a good PP look like?

Stocks: 100% Iceland Stock Exchange? No way. Just for starters that stock allocation would be too narrowly focused. The best bet would be a total world stock ETF. That would allow participation in prosperity anywhere it might be occurring in the world.

Bonds: 100% long term Iceland Gov Bonds? Maybe in 2005 that might have sounded reasonable, but from where we stand now, that would clearly be a bad choice. Better might be be long term sovereign debt equally weighted from the G8 or maybe the G20. I don't know how you could easily buy something like this, but we are speaking hypothetically.

Gold: The PP party line on gold is that it provides all the currency protection you need. Obviously it is a huge shield, and for the Icelandic investor it would have kept outcomes in the realm bad, rather than dreadful.

Cash: The PP idea on cash is that you want to keep it in the currency with which you pay your bills, because what if you have it all in dollars and euros and the krona suddenly surges. Then you lose. The local currency cash allocation is actually a nice counterbalance to the gold, in that it protects you against a local currency surge the way the gold holding protects you against a local currency collapse.

For the Icelander in 2005 though domestic bonds and stocks would not have been good choices. Much better would have been bond and stock holdings that were diversified across all major fiat currencies.

So that brings me to my question. How am I, apart from my terrible nasal twang and red neck, really different from someone in Iceland in 2005? Why don't I want maximum international diversification in my stock and bond holdings?  It seems like by diversifying these elements of my PP across all the big fiat currencies I'm protecting myself against anyone of them moving way out of line.

Keep in mind that the blow up of the Iceland stock market was preceded by massive gains. So an investor that chose not to diversify out of Iceland but followed the Permanent Portfolio was divesting out of stocks the entire time and buying the other assets. Yes, this would mean cash and LT bonds. But it also meant they were buying a large amount of gold with the stock profits and this significantly cut down on losses in 2008.

If I were in a very small country with limited economy though I would probably want to put more emphasis on international diversification. Someone in Belgium for instance probably wants to buy the entire EU stock exchange and not focus on Belgium stocks. Someone in Iceland may want to add more world international stocks to their allocation. The US however is still a *huge* economy and is in a totally different league than places like Iceland. Also remember that many US companies have large overseas operations and sell world-wide. So there already is plenty of international diversification in US companies. Think Ford, Coca Cola, Microsoft, GE, etc. They all make money from overseas business activities.

But also remember that all fiat currencies can inflate at any time. It is true that you may win some years by owning more foreign currencies, but you also may not. A US investor for instance that overweights the Euro may find that the problems of Greece in the Eurozone is affecting their investments much more than someone that wasn't overweighting international assets. These things can cut both ways.

craigr,

Thanks for the thoughtful reply. Also the podcasts are great.

You note that the exposure is a knife that can cut either way. I understand that and agree with you. The question I'm asking boils down to whether or not the PP as developed for a US investor has balanced the risk (probability x consequences) of being cut 50/50 each way.

The PP philosophy is based on probability agnosticism so we should ignore the probability term in the risk function and work to set the consequences term to 50/50. What are the upside consequences of diversifying into international stocks and long term bonds, and what are the downside consequences, and how do we adjust to make them equal?

Stocks: Leaving out the currency issue for a moment with regard to stocks, one upside to total market international stock investing is that you get to participate in prosperity where ever it may occur. Seems like this should reduce volatility in the stock holding in terms of performance vs a hypothetical average of all fiat currencies. Maybe that is a bad thing from the perspective of the PP stock portion interaction with the other 3 parts of the portfolio for an investor who pays for things with a non-hypothetical very specific local currency, but it seems incorrect somehow to leave participation in prosperity on the table. So what about the currency issue with stocks? We don't care whether it is more or less likely to help you or hurt you, we care whether it is going to hurt you worse than it can help you, but we also want moderation in the effect unless the effect is offset by a balanced change in some other component of the portfolio. Being a US-based investor would tend to moderate the effect since so much world stock capitalization is dollar denominated, but meditating on the possibility of a balanced change in some other part of the portfolio let's turn to bonds.

Bonds: I need to admit upfront that I am completely intimidated by bonds. The backwards yield/price thing, the difference between duration and term, yield curves... yikes. So I just want to ask a question. If an investor held a total world stock fund, would holding an equal-sized, similarly-portioned, total world long term bond fund cancel the currency term between these holdings on the portfolio?

Thanks.

Clive wrote: I opted to hold foreign currency invested in foreign stocks as the gold proxy as I suspect that generally that might be the simpler and more tax efficient approach compared to attempting to hold either ST or LT in foreign currencies/investments.

This all has really made me think that the standard three fund "Boglehead" US investor's portfolio (TSM, International Index, Bond Index) really has a lot more in common with the PP than some "diehards" may want to admit (not that there aren't big differences).

From a macro-perspective consider that gold has outlived every political and economic system devised by humanity since the dawn of civilization.

Here is one way of conceptualizing the matter: think of the human mind (and the collective mind of humanity) as the hardware, and think of human institutions such as political and economic arrangements as the software that humanity uses to organize and make sense out of the affairs of society.

Over time, software packages become obsolete, irrelevant, or simply cease to function.  (So does hardware, but that's another discussion--assume for now that we are dealing with hardware with a very long useful life.)  Thus, when viewed in terms of software, it should come as no surprise that virtually every institution designed by man has over time become obsolete and given way to successor institutions.

For reasons that I can't begin to fully understand, however, gold seems to hold an appeal to human beings that appears to be much more a part of the "hardware" of humanity's collective psychological make-up than a component of a transitory political or economic institution (i.e., the "software" on which human civilization runs).  There are analyses out there about why gold is a good monetary unit, but I'm not sure that captures all of the human fascination with gold. 

In light of the fact that man's fondness for gold has outlived every prior attempt at organizing society in an effective and meaningful manner, I don't see any reason to believe that this will change in the future.  (I'm not commenting on whether this makes any sense--I'm just observing the phenomenon.)

As an exercise, take a look at ANY period of history spanning 300 or more years.  What approach to asset allocation would have provided reliable protection during such a period?  I suggest that gold would have to be a part of any such attempt at durability in asset management.  Why 300 years?  Because it is beyond the horizon of most peoples' thinking, but the events occurring over a 300 year period have a high probability of affecting the life of anyone living a normal lifespan during such a period.  This is just a mental exercise that may be of some value in thinking about the role of gold in asset management.

This is a matter that each individual must think through for himself, but from a wealth preservation perspective, to me gold must be part of any allocation strategy, not because I think the world is going to end, but because I know that from a historical perspective virtually all human institutions tend to be transitory.  Part of the genius and subtlety of Harry Browne's thinking was that he was able to completely integrate this concept into an investment philosophy that allows one to live and enjoy life without fearing destabilizing changes, but which also allows one to be reasonably protected when such changes come along.

Clive,

I saw this post on Bogleheads and can't stop thinking about it.

Is the Excel file available for further tinkering?

Impressive stuff!