The Permanent Portfolio, Investing, Finance and Random Thoughts.
Risk and the Future
Let’s talk about risk and the future.
Sometimes I get a question about event X or event Y or event Z. These can sometimes be extreme events that someone is worried over. They often want to know how the Permanent Portfolio will deal with one or all of them.
My answer is that nobody knows what every possible hypothetical event will lead to in terms of unintended consequences. Even a portfolio you think will do best under event X may in fact do quite poorly if you guess incorrectly how the markets will react. Many investors in fact have been burned in just this very way. In other words, you can be right about a bad event happening, but totally wrong on how to invest to protect yourself from it. I never assume I know how the markets will react to a piece of news myself. I’ve been surprised often enough to know it just isn’t very profitable.
However what I most appreciate about the Permanent Portfolio is the fact that it is a way to diversify against a wide variety of serious or not-so-serious economic risks without having to guess about anything. As an entrepreneur, I like having options at all times to deal with the uncertain and the Permanent Portfolio does that. I don’t however spend a lot of time considering every possible scenario that could play out because it likely won’t happen that way. At least that’s what I’ve found in the business world and life in general. I think the best strategy continues to be one in which it makes no assumptions about any particular future, but at the same time gives an investor access to assets to accommodate even extreme situations if they show up.
For instance, let’s say the stock market dives by 50% tomorrow. If your portfolio was very heavy into stocks this would be a disaster. But if your portfolio is more Permanent Portfolio style the damage is limited. The 25% division of the four major assets of stocks, bonds, cash and gold limit your downside overall. Further, you would also have access to options to deal with the disaster (such as rebalancing into stocks with your cash, bonds and gold which is very likely the best option).
The Permanent Portfolio gives you options to deal with various contingencies if they should happen.
Or let’s say that happy days are here again and gold drops by 50%. That will be bad news for gold, but probably pretty good news for stocks. Take those profits and buy the yellow metal that everyone now hates because eventually they’ll want it again. Portfolio damage is limited because the downside of the gold can be absorbed by the upside in the stocks.
On the opposite end, if Treasury bonds tank and yields rise to 10% tomorrow the gold allocation will be there to deal with the very high inflation. This will allow a rebalancing into what is likely going to be lucrative high yields on your bonds once inflation comes back down. The gold gives you that option that a concentrated portfolio alone might not.
Finally, if you find out in 10 years that the US has gone to pot and a very dangerous government is rising to power you can make a decision to keep the gold separate and not rebalance. Instead you can hold the asset for the perceived emergency. There is nothing set in stone that says you must rebalance out of gold if you thought there was a extremely serious danger and you thought you’d need it. The future is unpredictable and because you hold the gold at least you have an option that other investors may not.
Each situation needs to be addressed when it comes about. However, the Permanent Portfolio gives you options to deal with various contingencies if they should happen.
I’ve never found that dwelling on doomsday scenarios to be very useful because the future rarely ever works out the way we think. Usually it is new and surprising outcomes that nobody expected that are the problem. Instead when you think about risk and the future, think of how useful a flexible portfolio with a wide range of assets is to deal with it. When I look at the problem that way, I’m glad I run the Permanent Portfolio and don’t concentrate my bets. I like having options and the Permanent Portfolio gives them to me.
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Well said, well said.
When you think about it, it’s really one of the most balanced approaches to investing. And just like in life: A balanced approach is frequently the best.
- Adam