Harry Browne's "Permanent Portfolio" of investing 25% in each of four asset classes is designed to incorporate four general stages or cycles we experience in the economy. Those four cycles are: prosperity, recession, inflation, and deflation. Years ago, Browne advocated investing 25% in stocks, 25% in cash, 25% in gold, and 25% in long-term treasury bonds as a way to cover each of the four economic stages.
The 25% invested in stocks takes advantage of periods of prosperity. Most portfolios over-emphasize this market stage, thereby increasing portfolio risk. The second stage, recession, is the period when the investor wants to hold cash. To protect against inflation ravaging the portfolio, Browne advocated putting 25% in gold. To buttress the portfolio against possible deflation, long-term Treasury bonds are assigned a 25% position.
The December 2012 issue of the American Association of Individual Investors Journal carried an interesting article, "The Permanent Portfolio: Using Allocation to Build and Protect Wealth." This AAII article states that over the last 40 years, the Browne allocation plan returned 9.5% compounded annually. From the AAII article, "The worst loss, a drop of 5%, occurred in 1981. In 2008's financial crisis, the portfolio was down only around 2% for the year." That is an amazing performance for such a simple yet conservative portfolio.
What investment instruments cover these asset classes? I would use VTI for stocks, TLT for long-term Treasury bonds, GTU for gold, and TIP for cash. I realize TIP is not a money market ETF, but I use it since the Quantext Portfolio Planner (see analysis below) rejects VUSXX or VMMXX in the analysis.
Browne QPP Analysis: Below is the QPP analysis for this four asset class portfolio. As background, the following analysis is based on a forecast that the S&P 500 will grow at a rate of 7.0% annually. This conservative four asset portfolio is projected to grow at 6.3% over the next six to 12 months, or slightly below the broad equities market. This low-risk portfolio is projected to have a standard deviation of only 7.6%, or well below our goal of 15% maximum.
The portfolio is sufficiently diversified as the Diversification Metric is 44%, or above our 40% goal. As expected, the Portfolio Autocorrelation is very low. This portfolio projects a Return/Risk ratio of 0.82, or well above our goal of 0.60.
Pay attention to the historical performance of these four ETFs over the last five years and compare it to the performance and risk values for the S&P 500. The five-year analysis period includes a major recession and a great bull market since the first quarter of 2009. The "Permanent Portfolio" performed about 10 times better than the S&P 500, while recognizing the S&P 500 is not an appropriate benchmark for this portfolio.
Correlation Matrix: One of the major advantages of the "Permanent Portfolio" is the low correlation between the asset classes. Instead of seeing percentages in the nineties, all the individual ETFs carry low correlations with each other. Those low correlations are modified when viewed in the context of the overall portfolio. Nevertheless, the "portfolio correlations" are still quite low, and that is the genius of the Browne "Permanent Portfolio."