Permanent Portfolio – Back to Basics

Thanks for the nice words, Ryan.

J,

You may like this recent post that discusses what you are asking:

http://crawlingroad.com/blog/2010/01/12/what-asset-will-do-best/

Last year I was reading advice telling people to avoid stocks because they were over priced and the Dow would drop to something like 4000. Stocks instead posted almost 30% gains. In 2008 I was reading advice saying inflation was coming when gas was around $4 a gallon and avoid Long Term bonds. Long Term bonds posted 30% gains. In 2007 I was reading advice telling people to diversify into real estate and stocks because bonds were a drag on portfolio performance. In that year the real estate market started to crash.

I could go on, but I think I’ve made the point. The markets are not predictable. I don’t care how many PhDs a person has, how many books they’ve written, how many magazine columns they’ve penned or how many interviews they’ve given on CNBC. Nobody can predict the future.

It’s possible that stocks and gold could fall in price. But it’s also possible that they won’t. It may seem counterintuitive, but if you own all the assets all the time you are actually safer vs. concentrating your bets. On a concentrated bet if you are wrong you can lose a tremendous amount of money. By distributing your investments however you mitigate the damages and are far less likely to encounter a “black swan” type event that does serious damage to your net worth.

There are no guarantees in life, but diversifying your savings is usually the best course of action.

Gold works the best. It’s a commodity and it’s also a monetary metal so you get two types of protection against inflation. Browne talked about this same question in one of his shows, I think October, 24, 2004. Commodities can have bull and bear markets that have nothing to do with threats of inflation. 2008 for instance saw commodities fall through the floor. But gold was up about 5% because when banks were teetering on collapse, and trillions of dollars in money being used for bail outs, people would rather own gold if they think inflation is going to be bad.

Also, I just don’t think you can diversify better than gold for a hard asset. When currencies are having problems, people think gold and not a basket of commodities. Finally, most commodity exposure is with opaque commodity futures funds and these can have many risks hidden inside of them. Gold is really simple to understand. You can own it physically or use a fund to get exposure if you need to. But it’s simple to understand and store vs. barrels of oil, wheat, etc.

Mike,

There usually is one asset in the portfolio that is not doing well. But it doesn’t matter too much because other assets are offsetting the losses. That’s why I tell people to not look at assets in isolation. You only want to look at how they work in the total portfolio. Also I just checked Morningstar and the iShares Treasury Long Term ETF TLT is up 0.56% for the year. Not stellar, but it is hardly taking a beating compared to 2009 where it took a -21% loss (yet the entire portfolio was up 8% the year).

I really don’t want all my assets doing well together because that means they can all do bad at once. 2008 was a prime example of portfolios that failed because what they thought was diversification was not. The assets that they owned that seemed to just keep going up every year all of the sudden turned down at the same time inflicting large losses. This doesn’t mean that you’re going to see -20% losses in assets each year. More like one may have some small loss, another could be flat, then one or two will be doing very well. The overall result is a positive gain.

I’ve heard the same arguments about Treasuries now for years. Yes, they could lose money. But then again we could have a deflation re-lapse and they could save the day as they did a couple years ago. Gold and stocks could both crash. We just don’t know.

Also consider that buying assets should not be done on the news you are reading. In fact, I’d say the more glowing reviews I hear about Asset X, the less I’m enthused about owning it. For all we know, the trashing of LT bonds could be the start of a new bull market.

TIPS are not recommended for the portfolio. They do not provide the deflation protection of nominal long term bonds. Nor do they provide the strong inflation protection of gold. They are also very expensive to hold for taxable investors if you are in that situation.

For me, I still own LT Treasuries and have for years. They pay me their interest and I ignore the talking heads. If I didn’t own them in 2008 my portfolio would have taken a tremendous loss. So I don’t think it’s a good idea to go fiddling around with the internals of the allocation. The future is not predictable.

P.S. Vanguard posted an article talking about surprises in bond markets for people thinking that short term bonds and TIPS may save them vs. long term bonds:

https://personal.vanguard.com/us/insights/article/bear-flattening-bond-surprise-04012010

Just some food for thought to show that there are good arguments for both sides of this debate.

Technically CDs are not as safe because you are relying on FDIC to back the banks if there is a problem. However this is a small risk. The bigger risk is going over FDIC limits on the CDs which you should never do because you could take a loss if the bank goes under.

The other problem I see people doing with CDs is chasing yields by putting money in shakier banks that are trying to entice new money with higher rates. Problem is though that the cash is supposed to be a stable part of the portfolio. So it’s the last place you want to take any kind of risk. This is why I just accept the lower returns on the cash with Treasury MMF and not worry about putting it into CDs. If you want to use CDs, make sure you stay under the FDIC limits and only put the money in banks that have solid books. However, I do think that a good Treasury MMF is safer. Especially if we ever have a serious banking crisis in this country again (like 2008 but worse).

On headlamps. I actually like headlamps the best and always carry one in my pack and in my cars. It’s easier to do things with your hands when you don’t fumble for a light. I think the major brands of lamps like Princeton Tec, Petzl, Black Diamond, etc. are all fine. Just get the LED version that takes standard AA or AAA batteries. They are all tough and run a long time.