The Permanent Portfolio, Investing, Finance and Random Thoughts.
Complicated costs. Simple saves.
I was going through some old investing books today getting ready to dispose of them to make room on my shelves. When paging through the candidates for removal, I saw so many complicated investing strategies. Some of the portfolio recommendations held 10 or more different mutual funds as part of their allocations! I bought these books early in my investment career and during that time they convinced me that only a complicated investment strategy could deliver diversification and performance.
Boy, was I wrong.
After looking back over the many years when I first bought these books it showed me this: Despite the complexity of these various strategies, not a single one of them added anything significant to investor diversification over this time. Owning a bunch of stock funds does not make you diversified. If anything, these approaches were tremendously risky for what you got out of them. Yet, the approaches hid those risks by making you think you had diversification because you owned so many different stock assets.
Well, stocks share the same market risks by and large because of the deep interconnections that exist between them all. Just because an investor owns some small company stocks, large company stocks, foreign stocks, etc. is no guarantee that a bad bear market can’t come up and bite them all at once. I didn’t go back and run the performance numbers, but my quick look predicts that over the period I owned the books they wouldn’t have done any better than a simpler portfolio. With the additional trading and management costs involved, there is a chance they did worse than a simpler approach.
This just reminded me how important it is to keep investing simple. Complicated investment schemes can hide many risks and expenses. The simpler you keep investing, the less chance you have of making a mistake. Investors don’t need to follow complicated investment plans to get good results. Indeed, I’ve found the simpler you keep investing the more likely you are to turn a good profit and not face any wicked surprises.
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Ned,
My looking back on many things I’ve read on this subject reveals that what many people think is diversification is really a play to grab more returns. They’ve just convinced themselves that owning a bunch of similar assets is not a veiled attempt to beat the market, but rather a prudent step to diversify.
It’s OK if people want to own a lot of different stock asset classes if they are being honest with themselves what they are really doing and using money they can afford to lose. However I find much more often than not they are living in a bit of denial about the whole subject of real risk. They will hide behind some academic or investing book to justify what they know they are actually trying to do (beat the market).
Like many, I’ve been burned myself in this regard. Experience, as they say, is an expensive teacher. You pay the tuition first, then you get the lesson.
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#3 written by Jim 2 years ago
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#4 written by J 2 years ago
Not sure why diversification isn’t a good idea within the 25% stock allocation. A quick glance at what kind of results that would produce based on data back to 1973 shows that it would result in higher returns with lower volatility for the overall portfolio – that can’t be a bad thing. The only negative might be more slices to rebalance into, but the change is only from 1 to 5 so that doesn’t worry me much.
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Hi J,
The main problem with splitting up the stocks so much is that there are more costs involved. I’m just not sure the cost of potential diversification is worth the added complexity, expenses and potential to lag the market when the small/value strategies are out of favor.
This debate had come up before and I guess my only advice is that to stick to the lowest cost and longest established index funds you can if you want to split up the stocks. I don’t think there will be either damage or benefit done whether it is split or not. But I do think the main diversification of the portfolio comes from the stocks, bonds, cash and gold major assets and not worrying too much about splitting up the stocks. So I’d worry first about the major asset allocation split before I thought about splitting the stocks.
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Gold was in effect IPO’d in the 1970′s, floating at a deeply discounted price level. The prolonged transition from high (double digit) interest rates in the 1970′s down to the more recent near 0% interest rates has favoured progressive stock and bond price appreciation.
Personally I’m prepared to devote a bit more effort in order to avoid relying upon the Permanent Portfolio style alone. The blend that I’ve settled for is a combination of Permanent Portfolio combined with Mebane Faber’s Quantitative model, which I anticipate being better at capturing rewards out of sideways zig-zagging markets than that of PP alone.
I’ve put up some web pages over at http://jfholdings.co.uk to record progress of that blend for anyone that might be interested.
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I find there is plenty of complexity in any investing without adding complexity of false diversification: you have tax shelter accounts, balancing across accounts, buying in lump sums versus dollar cost averaging, keeping track of your NAV, diversifying within the allocations (for example within stocks), geographic diversification, institutional diversification, and probably more I’m forgetting.
The permanent portfolio is simple for sure but more than that it is elegant. In science the elegant/simple solution is often the most powerful and useful despite being the easiest to understand.