Enhancing Harry Browne's Permanent Portfolio

Summary

• We describe and test the Permanent Portfolio, a simple and effective solution.
• We enhance it using monthly rebalancing and variable allocation.
• The resulting Enhanced Permanent Portfolio has a 9% yearly average return.

What is the Permanent Portfolio by Harry Browne

Harry Browne’s intention was to find a solution for the money “you need to take care of you for the rest of your life”. He called it the Permanent Portfolio because he believed that once an investor sets it up, they never have to re-arrange the allocations even if the outlook of the markets change.

He argued that this mix of assets should assure “your wealth will survive any event, including an event that would be devastating to any individual element within the portfolio”.

The portfolio consists of 25% Gold, 25% in the S&P500, 25% in Treasuries and 25% in Cash.

According to Harry Browne:

• Stocks should do well in periods of economic growth.
• Gold should do well during inflation, protect from currency devaluations and do fine during growth.
• Bonds should do well in deflation, ok during prosperity.
• Cash would protect from losses in a recession as well as deflationary environments.

As simple as this may sound, it is excellent advice. The Permanent Portfolio is one of the first and simplest type of Tactical Asset Allocation (TAA) portfolios. The strength of TAA’s come from combining uncorrelated asset classes that do well in different economic environments. The aim is to protect wealth and compound returns over the years. The purpose of this portfolio is not to outperform the market.

We will look at three versions, including our proprietary one that aims for higher returns.

• Version 1: No rebalancing, set and forget approach
• Version 2: Yearly rebalancing
• Version 3: The Logical Invest Enhanced version with monthly rebalance and variable allocation weights

The Buy and Hold Permanent Portfolio

The backtest assumes we just buy 1/4 the S&P 500, 1/4 Gold and 1/4 long term Treasuries. We never rebalance.

A 10 year backtest (2009-2019) with fixed allocations (no rebalancing at all) shows a 6% average yearly return. The most important aspect is very low volatility and maximum drawdown of -9%.

source: logical-invest.com - Statistics of the Permanent Portfolio vs its constituents SPY, TLT, GLD for 2009-2019

Going further back to 2005 we see that during the 2008 crisis the strategy suffered a bigger drawdown at -17 %. The compound average annual growth rate (CAGR) is 5.76%.

_{Extended Backtest of Permanent Portfolio from 2005 – 2019 source: logical-invest.com}

The above graph includes the 2008 crash, the S&P 500 bull market (2009 -2019), the Gold Bear market (2012-2016) and the start of rising interest rates (2016-2019).

The Permanent Portfolio re-balanced once a year

In this version we re-balance the portfolio every year and bring it back to the original allocations. If the value of Gold has risen and Treasury prices fell we could end up with a 35% GLD, 25% SPY and 15% TLT portfolio. At the turn of each year we rebalance back to 25% each.

_{Permanent Portfolio rebalanced every year. Backtest 2005-2019 source: logical-invest.com}

The 2005-2019 backtest is slightly better with CAGR of 6.21% and a maximum drawdown of 14.4%. A viable strategy even for a taxable account.

The Logical Invest Enhanced Permanent Portfolio (EPP)

We changed 2 things:

1. Rebalance monthly
2. Our algorithm determines the allocations to the three asset classes.

The algorithm considers the last 3 months. It runs all possible portfolios that consist of combinations of the three assets (i.e., 10% GLD, 0% TLT, 90% SPY) and records each portfolio's performance and risk. It then picks the combination that maximizes our modified Sharpe Ratio.

The volatility attenuator allows us to give a weight to the volatility or risk of an asset. If the volatility attenuator is 1, then we have a normal Sharpe formula with performance divided by volatility. If the attenuator is 0, then we rank only by performance without consideration to volatility or risk. A volatility attenuator higher than 1 means that we rather want low volatility assets, but still prefer a good return.

For this strategy we place more importance on minimizing risk. We use a volatility attenuator of 10, which means that we prefer low volatility portfolios. In practice this is very close to a minimum volatility algorithm.

_{The Logical Invest Enhanced Permanent Portfolio source: logical-invest.com}

The EPP backtest from 2005 to 2019 gives a CAGR of 9.6% and a drawdown of -13%. The enhancement comes with a cost to simplicity. The strategy rebalances monthly and is best suited for investors that self-direct 401k and IRA accounts.

Conclusion

The Permanent Portfolio is extremely easy way to construct a diversified portfolio. Rebalancing once a year has returned an average of 6.2%. By varying allocations depending on market conditions and rebalancing monthly we can enhance returns while keeping risk at low levels.

Analyst’s Disclosure: I am/we are long GLD, TLT, SPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Comments

[Proxima]

Thank ;you for your terrific article and my impression from reading Harry's books is that he came to the realization that no one can predict the future. Therefore what was needed was a strategy to hedge any potential economic scenario. Here is what I would do to modify his strategy for today :

1. 25 percent in stocks with the Vanguard total would fund symbol VT
2. 23 percent in GLD and 2 percent in Bitcoin
3. 25 percent in a laddered portfolio of Treasuries given that interest rate risk is high now.
4. 25 percent in cash

[abn70]

Great article and great comment stream. I plugged in Ray Dalio's All Weather portfolio and added a 4% withdrawal rate. Compared it to Harry Browne and the butterfly portfolio. Better return, better worst year and max DD, and better sharpe/sortino.

If you drop DBC in Dalio and double GLD, its even better. Have any of you played with the Dalio portfolio? Thanks!

www.portfoliovisualizer.com/...

[drftr]

Empty link I'm afraid... If you set up a strategy in pv.com then before publishing you have to clock on Link (placed just above the wide blue bar and/or chart section). Then you can copy the text from the address bar and use a link shortener like bit.ly to get rid of the spaces and non-allowed characters in the link, and that shortened link you can paste here in your comment here. Seems like a lot of work but once you've done it a few times it's really easy.

On topic:

Make sure you test different time frames before you decide. If you include 2020 in your test ANY strategy using gold will look good. Compare for instance how excellent real estate based strategies did until 2008 numbers were out. So those strategies were brilliant as long as you could test until 2007, horrible once you could include 2008, and today they look decent yet again. Same for gold here. Or try oil up to 2019. Now try up to 2020. I'm sure you know what I'm trying to say. And what happens with the last year or years of the test is also valid for the first years of course.

drftr

[abn70]

Thank you @drftr for both sets of help.

In reading your bio, I see we share the need to do more with our time than follow markets and study annual reports.

My strategy over the years has evolved to collect dividends, CEF distributions, and covered option premiums. Having income without selling assets during my retirement has been my mantra. So far its working. But I'm tired of the necessary time commitment to be a self-directed investor. I've looked at Ray Dalio and other asset allocation strategies but I'm struggling to cut that income cord. I'll keep looking.

You stay safe on your journey. I'm becoming a follower and look forward to following your comments.

[drftr]

Thanks for the kind words...

If you can live off your income stream and the income is safe that's obviously the best solution as you're virtually immune to price. So you won't be selling and/or buying too early or too late ever again.

drftr

[rizkhan]

What software are you using to perform the test?
What instrument are you using for CASH?

[Diego Quant]

Does the subscription service serve to trade in the futures market? or only with Etfs? thanks

[raopa]

New First trust Etf DALI (link) professionally rotates Equities, Fixed income, Commodities basket (including Gold) based on relative strength up 16% Year to date. Any user like DALI strategy? Thanks.
www.ftportfolios.com/...

[Varan]

Yahoo has data for DALI since 2018/5/15. Since then SPY has gained 4.4%, and Dali has lost 1%.

[drftr]

It triggered me to look at how the PERM ETF was doing but it doesn't seem to exist anymore, not unlikely because like many they tried to outsmart the original setup.

drftr

[bikeeagle1]

As a simple static portfolio, here is an improved version of the PP:
portfoliocharts.com/...

[drftr]

I must admit I'm a bit confused about the article. Maybe it's too early. Does it say "Buy the Permanent Portfolio and next to that invest in something else to give it a direction"?

drftr

[Varan]

Equal weight VTI, IJS, GLD, TLT, VBIRX. Not bad, but since 2003, investment in it on any date would have led to lower total return to-date than SPY, but higher total return than the Permananent Portfolio (VTI, GLD, TLT, VBIRX). Definitely an improvement on the Permanent Portfolio.

[bikeeagle1]

Here's more from the same site:
portfoliocharts.com/...

The idea is that, of the four market conditions planned for in the Permanent Portfolio, prosperity is the most often encountered. So, the Golden Butterfly allocates a double portion to stocks.

[Logical-Invest]

@pNinja Thank you for your comments. No we do not factor in the free rate in the selection process. We do however have a "Go-to-Cash' mechanism that we can input a theoretical risk-free rate (say 2%) so that when the algo cannot find combinations that can reach above that return, some funds will go to cash (or the risk free asset).

[Portfolio Ninja]

One more question for the author, do you subtract the risk free rate of return from the return when calculating the trailing sharpe ratio? I see that it is not included in your formula for modified sharpe.

[Bertrand22 CFA]

Portfolio Visualizer for this strategy returns 6.5% CAGR over the same 2005-2019 period when you get 9.6% (which surprised me). The DD are roughly the same.

www.portfoliovisualizer.com/...

[drftr]

In which case my 8.6% suddenly would look brilliant. I wonder what the difference is with their setup. Maybe fixed month length or so, or 4 week trading. Not sure.

drftr

[Cliff Smith]

@Bertrand22

I think your PV link might be similar to their second portfolio strategy, i.e. the one that had CAGR = 6.21% and MaxDD = -14.4%. One difference might be that they used pure cash in their portfolio, and you used CASHX (1-3 month treasury bills). But I think they are similar.

Thanks,
Cliff

[Portfolio Ninja]

Your PV link is for the buy & hold version of this portfolio which matches the first half of article (The Buy and Hold Permanent Portfolio).

The second half of the article uses the trailing sharpe ratio to determine the % allocations each month (The Logical Invest Enhanced Permanent Portfolio).

[Portfolio Ninja]

Do you apply any smoothing/filtering to the % allocations that are picked monthly?

Your allocations seem to change quite smoothly without any large jumps.

[Varan]

Two strategies requiring only yearly rebalancing may be just as good or even better, as the MaxDD is around 10% with similar CAGRs. https://imgur.com/fFuBGMW

Of course, since 2009, none of them has been able to do as well as SPY, and I suspect that the strategy of the author too has been equally under-performant.

[richjoy403]

...or you could simply buy one mutual fund, Permanent Portfolio (PRPFX), and own the Harry Brown portfolio, managed by Michael J. Cuggino since 2003.

Unfortunately, it has under-performed SPY's 17.2% TR for 8 of the last 10 years (6.54% TR), and already -4% YTD

[drftr]

PRPFX has little to do with the Permanent Portfolio. If you wonder why just look at its holdings.

drftr

[RandyFloyd]

@drftr can you be more specific? It is my understanding that Harry Browne was part of the construction of PRPFX, and later said that one could simplify using funds by creating the 25/25/25/25 mix.

[drftr]

Randy,

Have you looked at the mix? That aswers all questions :-)

drftr

[Cliff Smith]

Thanks for the article. I do have a question. It looks like you have eliminated cash as an element of EPP. It seems like cash is included in the first two portfolios, but not in EPP. Maybe I just missed it, so please clarify.

If cash is included at 25% in the EPP (if, indeed it was excluded in your article), then that would bring the CAGR down to about 7.2% or so. So EPP would still show some benefit, but just not as much as what you are showing.

Thanks,
Cliff

[drftr]

Admitted, the CAGR is only 8.6% instead of 9.6%, but the maximum drawdown is a whopping 50% better:

https://bit.ly/2HbqI73

drftr

[drftr]

Sorry, again the ^ in the ticker makes the link fail. Please delete it in the address bar, hit enter, then add it in front of the GOLD ticker.

drftr

[Cliff Smith]

@drftr

The PV link worked fine for me.

Thanks,
Cliff