Permanent Portfolio vs. 60/40 & 30/70 Portfolios

[hrux]

I apologize to belabor this point however recently have had a number of bogleheads and friends ask me about the PP versus a 60/40 stock-treasury portfolio and 30/70 value/small tilted portfolios.  Instead of answering them directly I thought I would post to this excellent forum and direct the traffic here.  Thanks in advance.  Which of the following investing strategies would you choose and why?  Thanks in advance.  Heather

Option #1 60/40
For simplicity let's assume 60% in Total World Stock (VT), 40% in Intermediate Treasuries.

Option #2 30/70
15% Small Cap Value (IJR), 15% Emerging (VWO), 70% in Intermediate Treasuries

Option #3 Harry Browne Permanent Portfolio
25% in Gold
25% in ST Treasuries (SHY)
25% in LT Treasuries (TLT)
20% in US Total Market (VTI)
5% in Emerging Market (VWO)

[foglifter]

I think you can foresee the answers given that this is a PP forum.
I wonder if you get any votes for #1 and #2.

I would choose #3 as it is the closest to the classical PP. I tilt to both small value and EM stocks.

[craigr]

I apologize to belabor this point however recently have had a number of bogleheads and friends ask me about the PP versus a 60/40 stock-treasury portfolio and 30/70 value/small tilted portfolios.  Instead of answering them directly I thought I would post to this excellent forum and direct the traffic here.  Thanks in advance.  Which of the following investing strategies would you choose and why?  Thanks in advance.  Heather

Option #1 60/40
For simplicity let's assume 60% in Total World Stock (VT), 40% in Intermediate Treasuries.

Option #2 30/70
15% Small Cap Value (IJR), 15% Emerging (VWO), 70% in Intermediate Treasuries

Option #3 Harry Browne Permanent Portfolio
25% in Gold
25% in ST Treasuries (SHY)
25% in LT Treasuries (TLT)
20% in US Total Market (VTI)
5% in Emerging Market (VWO)

I think that Browne's portfolio provides significantly better diversification. This translates into less volatile portfolio performance, lower draw downs, and less likely to be severely impacted by serious market events.

If the stock market is doing well then the heavier stock portfolios will do better. But better is relative. If you value a smoother ride and that keeps you in the market then the Permanent Portfolio is better. If you have a volatile portfolio that makes you bail out and start timing the market then the performance will be poor compared to the more stable Permanent Portfolio.

If you want to hedge your options, then make 50% of the portfolio the core Permanent Portfolio and put the other 50% into whatever other strategy you want for instance.

But I think the Permanent Portfolio gives me options as an investor to ride out good and bad markets. I like having options and I sleep very well at night knowing I run this portfolio.

I've seen a lot of stock/bond portfolios and so far none of them have made a great case on a risk adjusted returns basis. Even portfolios approaching 100% stocks have about the same performance as Browne's portfolio the past 30+ years. The only difference is Browne's portfolio has had about 1/2-1/4th as much volatility, much smaller losses in bad years, and a good record of returning real returns over the rolling 10 year periods. All of these things a stock/bond portfolio has a harder time claiming to have accomplished.

[KevinW]

I think all three are sensible, low-cost portfolios that will work for an investor with the discipline to stick with them.  I don't think there is any one unilaterally best portfolio, but rather that for every person, there's a portfolio ideally suited to their temperament.  If all of these have the potential to work and the biggest hurdle is persistence, then an investor should focus on picking the portfolio that helps them feel secure enough to stay the course.

Each of these portfolios has gremlins that will tempt an investor to capitulate and abandon the portfolio:

Option #1:
- Volatility.  This is a volatile, feast-or-famine portfolio that can depreciate sharply during stock bear markets.  A downturn toward the end of the accumulation phase can "erase" years of contributions.  Someone with a long term outlook, unswerving faith in capitalism, self control, and rationality ought to be able to implacably ride this out, but history seems to have proven that very few investors fit that bill.

Options #1 and #2:
- Intangible protection mechanisms.  These portfolios can protect against inflation, deflation, and recession, but through a gradual process of macro-economic market changes that are eventually reflected in indexes and later realized through rebalancing.  The PP has a direct link between economic conditions and assets, so when a bit of bad economic news shows up, the corresponding asset typically responds immediately.  Some people need this positive confirmation that the portfolio is providing effective protection.
- Chicken little.  These portfolios are invested 100% in paper assets, so if the economic system stopped working the portfolio would become worthless.  Regardless of whether these fears are rational or justified, they cause people to panic and make rash decisions.  The PP's hard assets can reassure investors that part of their portfolio will survive an apocalypse.  Even if an apocalypse never happens, this reassurance has a practical benefit of fending off capitulation.

Option #2:
- Infrequency of sector rallies.  Small-cap-value and emerging markets are rather narrow slices of the world stock market, and can experience long bear markets.  The portfolio may tread water for long periods between infrequent bursts of appreciation.  Some people are suited to biding their time between intense sprints, but many people need to see consistent and measurable progress.

Options #2 and #3:
- Unconventional.  These portfolios diverge from orthodox advice and attract confusion and ridicule.  People have varying levels of comfort diverging from the mainstream.  Also, investment vehicles for unconventional asset classes can be limited, especially in 401(k) plans.
- Tracking error.  Both portfolios are designed to generate consistent moderate returns regardless of what's going on in the stock market.  The financial media and general population live and die by stocks alone.  These portfolios will lag stock-heavy portfolios during bull markets, which creates temptation to abandon the strategy.  They are better suited to a slow-and-steady, non-competitive temperament.
- Reliance on rebalancing bonus.  A substantial portion of these portfolios' total return comes from capital appreciation induced by mechanical rebalancing.  This is an abstract concept and relying on it seems to require a leap of faith.

Option #3:
- Stigmatized assets.  Mainstream investing dogma states that gold and long term bonds are poor investments that are inappropriate for individual investors.  I would argue that the PP integrates these two assets into a cohesive portfolio, but their apparent shortcomings when viewed in isolation seem to be a dealbreaker for many people.

The best portfolio for you is whichever one meshes best with your personality and inclinations.