Do Dividend Aristocrats And The Permanent Portfolio Make The Perfect Match?

Includes: GLD, SHY, SPY, TLT
by: Sure Dividend


Find out if Dividend Aristocrats really improve the risk and return of the Permanent Portfolio.

The Permanent Portfolio was created by a former US presidential candidate and has a fantastic 4+ decade record.

The cash portion of the Permanent Portfolio can be viewed as inverse leverage.

Does volatility weighting assets improve Permanent Portfolio Performance?

Former Libertarian presidential candidate Harry Browne created the Permanent Portfolio. Harry Browne was an investment analyst in addition to a politician. He has sold over 2 million copies of his books, including Fail Safe Investing which details the Permanent Portfolio.

The Permanent Portfolio was created to provide positive inflation adjusted returns in any economic environment. It is meant to be an ideal vehicle to protect wealth from inflation and recessions, while still growing during deflationary periods and prosperous times. The portfolio consists of 4 equally weighted assets:

  • 25% Broad stock market (NYSEARCA:SPY)
  • 25% Long-Term Government Bonds (NYSEARCA:TLT)
  • 25% Gold (NYSEARCA:GLD)
  • 25% Short-Term Treasuries (NYSEARCA:SHY)

The ETFs listed above are proxies for the categories Harry Browne originally suggested. Low-Cost ETFs make implementing the Permanent Portfolio both cost-effective and time effective.

The Permanent Portfolio's high percentage of gold and short-term treasuries is immediately noticeable. Each item in the portfolio is meant to do well in different economic regimes. The 4 economic regimes the Permanent Portfolio considers are:

  • Inflation (GOLD)
  • Deflation (long-term government bonds)
  • Recession (short-term treasuries)
  • Prosperity (stocks)

The portfolio equally weights its investment for each economic regime. So how has the Permanent Portfolio done? It has performed extremely well over the last 4+ decades. Since 1972, the portfolio has had a CAGR of 9.3% per year, with a standard deviation of only 8%.

Source: Crawling Road Permanent Portfolio Historical Returns

Cash & Leverage

The cash/short-term treasuries portion of the Permanent Portfolio can be viewed not as a separate asset class, but as negative leverage. If you borrow money to invest in stocks, you are leveraging your portfolio. Similarly, if you only invest a fraction of your available money in stocks, you have reduced your leverage. The Permanent Portfolio is really 3 risky assets (stocks, long-term government bonds, gold) leveraged to .75 instead of fully invested.

If one invested equally in stocks, long-term US bonds, and gold for the same period (1972 through 2013), your portfolio would have a CAGR of 10% with a standard deviation of 10.3%.

Source: Crawling Road Permanent Portfolio Historical Returns

Dividend Aristocrats Improve Permanent Portfolio Performance

Dividend Aristocrats have historically outperformed the stock market. Replacing the stock market portion of the Permanent Portfolio with Dividend Aristocrats significantly improves both portfolio return and volatility.

Source: Sure Dividend

Risk Adjusted Weights

The equal weights of the Permanent Portfolio do not spread risk among assets in an optimal manner. By weighting each asset class of the Unlevered Dividend Aristocrat Permanent Portfolio by inverse volatility as opposed to equal weighting, we can further improve upon the Permanent Portfolio while still adhering to the portfolio's underlying principles.

Gold has historically had a higher standard deviation than long-term government bonds and Dividend Aristocrats. The Dividend Aristocrats index has been about as volatile as long-term government bonds. Adjusting for volatility, the Unlevered Dividend Aristocrat Permanent Portfolio has the following weights:

  • Dividend Aristocrats (35%)
  • Long-Term Government Bonds (35%)
  • Gold (30%)

Adjusting the weights of each asset class in the Permanent Portfolio for volatility slightly increases return while slightly reducing volatility.

Source: Sure Dividend

Final Thoughts

The Permanent Portfolio works by spreading risk across uncorrelated asset classes and harvesting correlation gains by rebalancing annually. The portfolio has historically done very well. Replacing the total stock market section of the permanent portfolio with Dividend Aristocrats and adjusting asset class weights for volatility has historically improved the Permanent Portfolio's return while reducing risk.

The Permanent Portfolio is an excellent option for risk averse investors and retired investors who need to make solid returns on their investments while avoiding large drawdowns. Large drawdowns are significantly worse for investors who are already cashing in their portfolio on a regular basis as it forces you to 'sell low.'

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.