Gyroscopic Investing

Hello,

I am hoping that the experienced users here at the blog will help me make sure I understand the Permanent Portfolio (PP) and provide answers to a few questions.  I read Fail-Safe Investing and have been reading this blog, threads at the Bogleheads forum, and other websites such as madmoneymachine.com, over the last several weeks.  I wish to thank the many folks here who have asked questions and shared their knowledge and experience.

My understanding of the PP is that the portfolio is based on economic drivers, so that the PP will perform in various economic conditions relying on a synergy between the four parts of the portfolio to produce a real return above inflation.  The PP has performed great over an extended period of time.  Furthermore, I am seeing about a 15-18% maximum drawdown with (PP).  In other words, a great portfolio for conservative investors like me.

However, I am still hesitant to utilize the PP over a more conventional portfolio (CP) (e.g., 25% small cap value and 75% five year treasuries – 1972- 2008 CAGR 9.83%, 7.78 standard deviation, 2008 return of 1.98%, lowest return -3.62% in 1994 - http://www.assetplay.net/financial-tools/backtest) that produces roughly the same performance as the PP, because my perception of risk is that the PP is actually riskier than a CP.

In other words, a CP appears to give a more reliable return because the majority of the portfolio is based on relativity low risk investments, e.g., five year treasury notes, that intrinsically produce a return and do not rely on a capital gain like the gold portion of PP or a theory regarding a portfolio based on economic drivers that no one can predict will continue to perform as it has done in the past (I believe I saw a comment by Medium Tex at Bogleheads that a negative rolling three year return for the PP would lead him to reconsider the PP).

On the other side of the coin I realize that the CP does not really have any protection against currency debasement or hyperinflation like the PP.

If you have read to this point I am hoping that you will post a comment as to whether my perception of risk is flawed and why you think that it is flawed.  I have considered utilizing both the PP and a CP, but would appreciate opinions on a PP versus CP only basis.  Please do not hesitate to be blunt.

Thanks for your help.

Your thinking is fine and you apparently understand the trade-offs. I would point out again what you already know that the portfolio of 25/75 stocks/bonds has almost no protection against a serious currency problem. So I think high inflation is going to bite into the real returns pretty hard. This has been the case in the past.

Personally, I just can't bring myself to own a portfolio with no exposure to hard assets like gold. I think that you lose a big piece of diversification when you eliminate hard assets and just own stocks and bonds.

As for what is "less risky." Well that's really unknown because volatility is backwards looking and we don't know what it will do going forward. My gut instinct looking at the issue for some time is that the four asset Permanent Portfolio is probably less risky because it is not concentrating bets. The 25/75 portfolio owns a huge slice in bonds and if that bet goes south (likely due to bad inflation or even extreme events like defaults) then the portfolio could take a serious beating.

I think your hypothetical portfolio is definitely better than most, but is actually riskier than it seems because of factors you already alluded to: lack of protection against currency debasement and hyperinflation. Additionally, due to the short duration of the treasuries, it also lacks deflation protection and responds only weakly to changes in interest rates. Furthermore, what if small-cap value stocks reverse their recent trend and begin to underperform large-caps, growth stocks, or the total market?

Also, note that the rolling 10-year CAGR of this portfolio has been steadily driven down by falling interest rates:

http://www.riskcog.com/portfolio-theme2.jsp#5745lbd


If interest rates continue to fall and we "go Japanese", this portfolio will look very risky indeed. I would definitely encourage you to at least add some gold, possibly even splitting your bonds and allocating half of that money to gold. That would make it much more robust IMHO.

First off you need to identify the risks you are concerned about, the risks of each of the portfolios, and then you can determine which is "more risky."

From your description, it sounds like the primary risk you are concerned about is preservation of capital value.  If that is true, you should probably consider only a savings account or certificate of deposit or U.S. Treasuries.  Those are all just about equally safe (as long as you stay under the insurance limit for the bank products) in that you are extremely likely that your capital will be returned to you intact, with a little bit more for your trouble.

You also seemed to express some concern about the rate of growth of your capital.  I can tell you right now, nothing with capital safety is going to give you any significant growth at the present time.

Those are the only risks you seem to be concerned about.  If that is true, then the PP is probably not right for you.  You should probably choose a more typical portfolio with an emphasis on a prosperous economy with mild inflation.

The PP is designed for all 4 economic conditions (prosperity/recession, inflation/deflation), with the assumption that you don't know what is coming up next.  With those constraints, the PP is going to be sub-optimal at growth in all of the economic conditions, but will provide some growth in most and will protect the purchasing power of your capital (not necessarily the nominal value) better than a strategy designed without consideration of all 4 conditions.

@ BP

I understand you very well.
Probably you are going to do something like 50% PP + 50% CP
Bogle type portfolio you don't like?


@craigr

where do you sell physical gold in US?
Are you 100% PP?


@ Pointedstick  @AgAuMoney


"but will provide some growth in most and will protect the purchasing power of your capital (not necessarily the nominal value)"

can you explain this sentence to me.



Thank you ALL

A portfolio with 75% of its allocation to a bond that is currently paying a negative real interest rate, with no protection in the portfolio against rising interest rates or currency devaluation doesn't sound very appealing to me, regardless of past performance.

BP wrote: Hello,

I am hoping that the experienced users here at the blog will help me make sure I understand the Permanent Portfolio (PP) and provide answers to a few questions.  I read Fail-Safe Investing and have been reading this blog, threads at the Bogleheads forum, and other websites such as madmoneymachine.com, over the last several weeks.  I wish to thank the many folks here who have asked questions and shared their knowledge and experience.

My understanding of the PP is that the portfolio is based on economic drivers, so that the PP will perform in various economic conditions relying on a synergy between the four parts of the portfolio to produce a real return above inflation.  The PP has performed great over an extended period of time.  Furthermore, I am seeing about a 15-18% maximum drawdown with (PP).  In other words, a great portfolio for conservative investors like me.

However, I am still hesitant to utilize the PP over a more conventional portfolio (CP) (e.g., 25% small cap value and 75% five year treasuries – 1972- 2008 CAGR 9.83%, 7.78 standard deviation, 2008 return of 1.98%, lowest return -3.62% in 1994 - http://www.assetplay.net/financial-tools/backtest) that produces roughly the same performance as the PP, because my perception of risk is that the PP is actually riskier than a CP.

In other words, a CP appears to give a more reliable return because the majority of the portfolio is based on relativity low risk investments, e.g., five year treasury notes, that intrinsically produce a return and do not rely on a capital gain like the gold portion of PP or a theory regarding a portfolio based on economic drivers that no one can predict will continue to perform as it has done in the past (I believe I saw a comment by Medium Tex at Bogleheads that a negative rolling three year return for the PP would lead him to reconsider the PP).

On the other side of the coin I realize that the CP does not really have any protection against currency debasement or hyperinflation like the PP.

If you have read to this point I am hoping that you will post a comment as to whether my perception of risk is flawed and why you think that it is flawed.  I have considered utilizing both the PP and a CP, but would appreciate opinions on a PP versus CP only basis.  Please do not hesitate to be blunt.

Thanks for your help.

I combine both and I'm quite happy with it. Let's see, I have a 50/40/10 allocation:

35% sliced and diced US stock market
15% sliced and diced international stock market
25% total bond market fund
15% intermediate TIPS fund
10% gold fund

Yeah I'm heavy stocks, but I'm also 33 years old. If I was 53, it wouldn't look like this. Slicing and dicing the stock market was a coin-flip personal decision. It won't make a big difference 20-30 years from now, I'm certain of it. Gives me a few more funds to rebalance which is a pain but potentially a profitable pain.

I have 15% in TIPS and 10% in gold which gives me a PP-like 25% inflation protection portion of the portfolio. And the 25% in total bond is hardly any different than holding a 12.5/12.5 treasury barbell. A little different maybe, will it make a big difference 20 years from now? Probably not.

Changes I'm considering:
1) rebalance gold/TIPS to 12.5/12.5% - probably won't make much of a difference
2) due to very limited tax advantaged space, considering getting rid of total bond/TIPS altogether and using intermediate muni bonds in taxable and EDV or long duration TIPS (LTPZ fund) in tax advantaged
3) same as #2 but going with EDV or LTPZ in tax advantaged and intermediate treasuries in taxable for the safety factor

I have some capital losses in the bond funds right now so I can move on those w/ no tax damage. I'm very confused about what to do with bonds though.

In a variable portfolio I hold Apple, which comprises of 3% of my total if you added it into all of the above. I also hold cash in an emergency fund which I don't include in any of those %'s. The Apple decision was horrible, go figure. I'm almost glad that trade hasn't worked out. I'll make that money back eventually I'm sure, but it has soured me completely from the idea of picking stocks which is for the best.

Anyway, it's not a PP and it's not CP. But I feel like I'm pretty well diversified. Some days I wish I had more gold, but then I tell myself that at least I have some. Some days I wish I had less stock, but I tell myself at least I'm not 70/30 like many would suggest for someone my age. Insert any "I wish I had XXXX" in there and I can justify it pretty well with this portfolio. Just thought I'd post this so you know there's a happy person out there with a blended portfolio.

For what it's worth, the PP is no different than a 25/50 CP with 25% gold. The added gold is the only difference. But I'm sure you already know this.

frugal wrote:
"but will provide some growth in most and will protect the purchasing power of your capital (not necessarily the nominal value)"

can you explain this sentence to me.

Two parts.

Part 1. In most economic conditions, the permanent portfolio will provide some growth.

If the stock market is booming (like 1998-9), an all stock portfolio will likely grow about 4x as fast as the permanent portfolio (but of course it depends on the other 3 assets, 2 of which could well be declining).  But probably there will be some growth because of the stocks.

In recessionary inflation (stagflation, like 1974-1981) stocks mostly go nowhere but maybe down, bonds are losing purchasing power and are likely not doing much unless interest rates rise which sends them down, cash is losing purchasing power but going up as you can probably get 5% or more in a savings account and 10-15% in a CD, and gold is likely going up.  This produces some growth.

Part 2. In most economic conditions the permanent portfolio will protect the purchasing power of your capital (but not necessarily the nominal value).

First you need to understand "nominal value" vs. "real value."  "real value" is what I called "purchasing power."  Nominal value is the dollar figure you are used to thinking of as "the value."

A $20 bill has a nominal value of $20.  But the "real value" of that $20 bill compared to $20 in 1914 is less than $1.  Or think of having your $20 bill or a 1930 $20 gold coin.  In 1930 they were the same value, but the "real value" of the $20 bill has declined while its "nominal value" has been preserved.  That's bad.  Much better is to protect your purchasing power, or the "real value" of your assets and you really shouldn't care about the nominal value.  In fact, if the nominal value goes up you get to pay taxes on the increase, even if the "real value" goes down!  Much better if the nominal value goes down as long as the real value is stable or increasing.

What happens in a deflationary recession?  Stocks are going down.  Gold is likely going down.  Bonds might go up if interest rates can go down, but if interest rates cannot go down then bonds will stagnate or even go down (such as if interest rates start to climb because borrowers become desperate for cash and are willing to pay more in the future for cash now).  Cash doesn't go down, might go up a bit, but not likely it will go up enough to counteract the decline in the other three assets.  BUT WAIT!  Because of deflation the purchasing power of cash is increasing, the purchasing power of gold is stable or possibly increasing, the purchasing power of your stocks and your bonds are stable or possibly increasing, so even if the nominal dollar value attached to your portfolio is going down, your purchasing power is preserved and may even be growing in real terms.


There are many possible combinations of the four economic conditions.  In those two parts I've used just a few to illustrate how the PP might behave in those scenarios.

AgAuMoney

by your avatar I see that you like coins. What do you hold as silver and gold ?

When do you buy? I'm thinking on rebalancing by buying physical gold instead of ETFs. It seems to me that I prefer to buy Gold on sales...


Thank you so much for your replies.

CraigR:  Thanks for letting me know that I am properly considering the issues.

Pointedstick: Thanks for the feedback and suggestions.

Agaumoney:  Thanks for the suggestion.  I am thinking that the after tax return will be negative.  This why I am considering the PP.  However, my spouse would definitely follow your suggestion!  Nice comments to frugal's question.

Frugal:  Thanks for the comments.  Could end up being a combination of some sort.  Still reviewing other options, e.g., Zvi Bodie.

Mediumtex: Thanks for the comments.  I read similar comments regarding portions of the PP at other websites as reasons for not investing in the PP, e.g., not going to put my 50% in "non-performing assets" like cash and gold.  I guess it depends on ones perspective.  Although intellectually I agree that we cannot predict performance for any investment, including the PP, emotionally the run up in gold prices and inflationary pressures gives me pause about gold an LT bonds.

Iwealth:  Thanks for the suggestions and ideas.  I am going to post a variable portfolio challenge that might be of interest to you.

Thanks again!

BP wrote: If you have read to this point I am hoping that you will post a comment as to whether my perception of risk is flawed and why you think that it is flawed.  I have considered utilizing both the PP and a CP, but would appreciate opinions on a PP versus CP only basis.  Please do not hesitate to be blunt.

The simple solution to your dilemma is to use 5-year Treasury ladder for the cash and invest a portion in small caps for the stocks.  Strict adherence isn't necessary as the PP is about economic regimes, not asset classes.  Just as long as you realize there is potential tracking error.

frugal wrote: What do you hold as silver and gold ?

When do you buy?

I have some physical, but the vast majority of my metal is current in Central Fund of Canada (NYSE:CEF).  It is a closed-end fund (known as a CEF) that holds about 1/2 silver and 1/2 gold by value.  It has been around since the 1960's and has a good reputation.  The same family owned company also start a the Gold Trust (NYSE:GTU) a few years ago and a Silver Trust more recently (trades only in Canada).

I do like coins, very pretty.  I also like bars and ingots.    Problem is the cost to buy, sell, store, etc. physical, both in terms of dollars and hassle factor, is too high for me to hold more than just the core in physical.

My buying strategy is to dollar-cost average.  I don't know when the market is high or low or where it is going, but for about 6 years I'd set aside some dollars out of every paycheck into physical instead of 401(k) or brokerage account.

I haven't been able to add much to my investments the last few years, so I haven't been buying physical except rarely.  Probably every 4 months or so I'll get a call from a coin dealer I've dealt with asking if I'm interested in what he just purchased or if I want to join in a group buy and I've taken him up on it a few times.

When I'm actively watching the market I do some trading between IAU + SLV and CEF.  Since CEF is a CEF it will trade at a premium or discount to its Net Asset Value (or NAV) depending on the ratio of buy to sell interest.  Rarely a discount the past 10 years, but the premium frequently ranges from almost nothing to nearly 10%.  I may not know where the premium is heading in the short term, but I do know that historically when the premium stabilizes above about 7%, they add more units to the fund which knocks the premium back down.  So if I sell part of my position at what seems to be a high premium, and store the cash in IAU and SLV, I'll likely get a chance to buy back into CEF at a lower premium in the future.  But CEF is my parking spot.  Reasonable costs, and I trust them more than I trust IAU and SLV.

AgAuMoney wrote:

frugal wrote: What do you hold as silver and gold ?

When do you buy?

I have some physical, but the vast majority of my metal is current in Central Fund of Canada (NYSE:CEF).  It is a closed-end fund (known as a CEF) that holds about 1/2 silver and 1/2 gold by value.  It has been around since the 1960's and has a good reputation.  The same family owned company also start a the Gold Trust (NYSE:GTU) a few years ago and a Silver Trust more recently (trades only in Canada).

(snip)

Actually, the silver closed end fund run by the CEF/GTU folks trades in the US OTC market as SVRZF, which is the same fund as SBT on the Toronto exchange.

rickb wrote: Actually, the silver closed end fund run by the CEF/GTU folks trades in the US OTC market as SVRZF, which is the same fund as SBT on the Toronto exchange.

Oh, thanks for the update!  That line was not on their website the last time I looked.  (Which I thought was only a few months ago, but I can't be sure it was a year or two.)