Permanent Portfolio By A Different Name

Includes: TIP
by: Roger Nusbaum

Jason Zweig had an article over the weekend that although it didn't say so, offered a variation on the Harry Browne permanent portfolio. Browne advocated for 25% each into stocks (via a broad, domestic index fund), long-term bonds, gold and cash with the idea being that this mix would always have at least one thing doing well no matter what came along in the world. The results have generally been quite good looking back but obviously the past 30 years has been a heyday for long-term bonds.

Zweig found an advisor who uses four different buckets than Browne; expansion where you would have stocks, real estate and commodities, recession where you would have bonds, in the inflation bucket you would have TIPS and commodities again and in the deflation bucket you would have stocks and conventional bonds.

Note that the suggestions in the preceding paragraph are from the article, not from me. The comments on the article are worth reading. The article points out that allocations like this are not about striking it rich but more about preserving the nest egg and growing it slowly. Any mention of nest egg merits this photo of Albert Brooks and Julie Hagerty from Lost In America.

I tend to believe that the best path is a simple stock bonds cash allocation but it is still worthwhile to explore these types of ideas all the same. They can be a useful influence on a simple portfolio and maybe one these alternatives will turn out to be the Holy Grail.

The starting point of the article was that the blending together of historically lowly correlated assets works great until a crisis comes along like in 2008 when correlations went way up and almost everything went down a lot at the same time.

Conceptually these buckets are interesting and I would add a fifth that I think is consistent with preserving the nest egg and growing it slowly; an emergency cash bucket for however you define emergency. This could include X number of month's expenses, an amount equal to the biggest one-off emergency you've ever had or something else but an amount sufficient to make you comfortable.

The contents of each bucket as outlined in the article seemed a little thin because of the overlap in buckets. It may also not be especially forward looking either especially for the inflation bucket. I am a huge believer in TIPS exposure, buckets or otherwise, and TIPS have done well generally but for the last few years headline inflation has been nonexistent, but it has been pretty high for several real world expenses like health insurance. In the future, if inflation looks the same as it has for the last few years and rates are moving up then TIPS might not be very effective.

As far as commodities working well as inflation protection everyone probably understands the argument and I generally believe in it to a point but there is some measure of reliance on the next inflationary period being like the one in the mid to late 1970s. It probably will be similar but what if it is not?

There needs to be a little more detail to simply putting equities in both the expansion and the deflation buckets. Anyone actually doing this strategy would probably want deeper cyclical stocks and other generally more volatile segments in the expansion bucket. In the deflation bucket you would probably want more defensive exposure and a distinction needs to be made between a deflationary environment which we kind of had a few years ago and a true deflationary debt spiral which a lot of people were worried about a few years ago but never actually materialized (yet?). In a true deflationary spiral you probably don't want equities.

It is not practical construct a portfolio today that can protect against unknown crises tomorrow because we don't know what tomorrow's crises will look like. Maybe there will be some event where we should own a lot of foreign currencies or something else not included in the article. One assumption in the article seems to be that you need to construct your protection now and don't bother trying to analyze what comes down the road later. For someone who is actively engaged in markets it makes sense to understand how the next crisis starts to unfold (there was plenty of warning ahead of the Great Recession which I wrote about in 2006 and 2007) and reallocate accordingly.

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