Harry Browne had this to say about the permanent portfolio:
"The portfolio's safety is assured by the contrasting qualities of the four investments - which ensure that any event that damages one investment should be good for one or more of the others. And no investment, even at its worst, can devastate the portfolio - no matter what surprises lurk around the corner - because no investment has more than 25% of your capital."
The permanent portfolio consists of
- 25% - Stocks (S&P 500 Stock Index Fund)
- 25% - Long Term Bonds (US Treasury 30 Year Bonds)
- 25% - Gold (Physical Gold Bullion)
- 25% - Cash (Treasury Money Market Fund)
Harry Browne believed no matter what was happening in the economy at least one of the assets in the Permanent portfolio would be doing well:
- Stocks - Prosperity
- Long Bonds - Deflation
- Gold - Inflation
- Cash - Recession
In theory having at least one asset always doing well would prevent the portfolio from incurring large losses. Below we show how the portfolio has performed from 1972-2014 compared to a 60% US Stocks/ 40% long-term bond portfolio and the S&P 500.
All the charts and data in this article are from portfoliovisualizer.com
If you look at the third column above, it shows the compound annual growth rate. Comparing it to the returns of the other portfolios, you may think the permanent portfolio does not have a very good return history. However, CAGR is only part of the story.
Look at how smooth the blue line in the graph is. The Permanent Portfolio has better risk adjusted returns based on both the Sharpe Ratio and the Sortino Ratio. Look at the column that shows the worst year for the portfolios; the worst year for the Permanent Portfolio was -5.43% compared to -20.24 (60/40) and -37.02 (S&P 500).
While the Permanent Portfolio has not produced outsized gains, it has delivered what Harry Browne said it would; steady returns while avoiding devastating losses.
Performance of the Permanent Portfolio in the Withdrawal Phase
Avoiding large drawdowns is important for any investor, but it is especially important to retired investors. A large drawdown combined with withdrawals can reduce a nest egg to dangerously low levels. The worst time to experience large drawdowns is early in retirement.
In the period from 1972-1981 portfolios had a hard time keeping up with the extremely high inflation. Back testing a retirement starting in 1972 provides and excellent stress test. Below we back test the portfolios with an initial value of $100,000 and withdrawals following the 4% rule. Withdrawals start at $4,000 and are adjusted each year to account for inflation.
Now we can see the benefit of the smoother returns provided by the permanent portfolio. Even with withdrawals the worst drawdown for the permanent portfolio is only 9.17%, compared to over 30% for the 60/40 portfolio and over 50% for the S&P 500 Portfolio.
If we backtest the same time period, but we change the original withdrawal amount to $6,000 (6%) and adjust the withdrawal each year for inflation:
- A retiree invested in the S&P 500 would have run out of money in 1986 (14 years)
- A retiree invested in the 60/40 portfolio would have runs out of money in 1989 (17 years)
- A retiree invested in the permanent portfolio would have run out of money in 2004 (32 years)
A retiree invested in a portfolio that is has extremely low volatility, like the Permanent Portfolio, can increase his withdrawal rate. In the comparison of these three portfolios, this was true even though without withdrawals the Permanent Portfolio had the lowest CAGR.
So what's not to like?
My first concern is the gold. I agree with Warren Buffet about gold:
"Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head."
It is hard to understand why gold is highly valued; it is not a very useful metal. On the other hand another quote from Warren does give gold a sort of backhanded compliment:
"Gold is a way of going long on fear, and it has been a pretty good way of going long on fear from time to time. But you really have to hope people become more afraid in a year or two years than they are now. And if they become more afraid you make money, if they become less afraid you lose money, but the gold itself doesn't produce anything."
There are times when investors are going to be afraid of other assets and they are going to turn to gold -- or at least this happened frequently in the past.
My other concern with this portfolio is most investors can't stick to it. Most of us compare ourselves to some yardstick or other, an index, a friend's portfolio, portfolios we see on Seeking Alpha, something. The problem is the Permanent Portfolio is not going to track any of those portfolios. Its sequence of returns is going to be extremely different than those yardstick portfolios. Which means at times it is going to underperform in a big way and possibly for a long time.
From 1980-1999 the US stock market was on a tear. The Permanent portfolio returned a perfectly acceptable 8% CAGR, but our two other portfolios blew it out of the water. Look at column two, the final balance for each portfolio. I'm sure not many investors had the discipline to stay with the permanent portfolio during that time period.
Over the next decade (2000-2009) they may have wished that had; they would have gotten better returns with a lot less heartburn.
The original portfolio called for Gold Bullion, which is not an option most of us would consider. The tests run at PortfolioVisualizer used:
- KITCO returns (kitco.com) 1972-2004
- GLD ETF 2004-2014.
If you were going to implement the Permanent Portfolio with funds, here are some options:
- Vanguard 500 Index Fund(MUTF:VFINX)
- Vanguard S&P 500 ETF (NYSEARCA:VOO)
- Schwab S&P 500 Index (MUTF:SWPPX)
- SPDR® S&P 500 ETF (NYSEARCA:SPY)
Long Term Treasuries
- Vanguard Long Term Treasury (MUTF:VUSTX)
- iShares Barclays 20 Year Treasury Bond Fund (NYSEARCA:TLT)
- Vanguard Extended Duration Treasury Index Fund (NYSEARCA:EDV)
- iShares Gold Trust ETF (NYSEARCA:IAU)
- SPDR Gold Trust ETF (NYSEARCA:GLD)
- ETFS Physical Gold Shares (NYSEARCA:SGOL)
- iShares Short Treasury Bond ETF (NYSEARCA:SHV)
- iShares 1-3 Year Treasury Bond ETF (NYSEARCA:SHY)
- Vanguard Short-Term Government Bond Index (NASDAQ:VGSH)
- SCHO Schwab Short-Term U.S Treasury ETF (NYSEARCA:SCHO)
- SHY, VGSH, SCHO have longer durations than Harry Browne recommended, but 1-3 year treasury funds are often recommended by other advocates of the Permanent Portfolio.
Modifying my Retirement Portfolio to look More Like the Permanent Portfolio
I discussed my retirement portfolio in a previous article. It does not contain any gold and much less cash than the Permanent Portfolio. I was curious how my portfolio would back test if I modified it to look a little more like the Permanent Portfolio.
To bring my portfolio closer to the Permanent portfolio
- I added gold
- Reduced the equity allocation
- Changed the composition of the treasury allocation
Based on the backtest, my portfolio would do better if I adjusted it to look more like the permanent portfolio. The adjusted portfolios have lower drawdowns, better risk adjusted returns, and a similar CAGR. The portfolio with 15% allocated to gold does particularly well. It's an intriguing result and I plan on investigating it further.
Will any Commodity do?
I was curious about what the result would be if I substituted other real assets for gold. I modified the portfolios above and changed the gold allocation to an allocation of commodities. PortfolioVisualizer uses the following commodity data:
- Chase Physical Commodity Index 1972-1990
- DJ-AIJ plus T-Bills 1991-1996
- DJ-AIG plus Yahoo's IPS "category" returns 1997-2001 (prior to VIPSX)
- DJ-AIJ plus VIPSX 2001-2002
- PIMCO Commodity Real Return Strategy Fund (MUTF:PCRIX) 2003-2014
The portfolios with commodities had better risk-adjusted returns than my portfolio, but the risk-adjusted returns were not as good as the portfolios with gold.
The past can be used to give us some insight into the future, but the insights must be used with some caution. Market situations now and in the future will never exactly match what has occurred in the past. Backtesting provides some useful information, but its ability to predict future performance is far from perfect.
- The permanent portfolio is not a homerun hitter, but it has produced steady returns and done a remarkable job avoiding large losses.
- For someone in retirement, the low volatility of the Permanent Portfolio should be especially appealing.
- The major problem with the Permanent Portfolio is because it does not track any of the usual portfolio yardsticks; investors have a hard time sticking with it.
- I'm skeptical about gold, but adding it to a retirement portfolio may be an idea that has some merit.
I am not a professional advisor or researcher. I am an individual investor who studies investing and shares my thoughts. I encourage all investors do their own due diligence and please share your findings. I strongly feel that the primary benefit of Seeking Alpha is the sharing of ideas. Please comment; I value your input. Divergent opinions are welcome.
Disclosure: The author is long TLT, SCHO. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.