I posted this as a response to a thread over at the Boglehead’s forum where someone asked the provocative question about the Permanent Portfolio being “best.”

Well I’m pretty big on the portfolio (I co-authored a book about it), but I’m not going to say it’s “best”, I’ll simply list out the pros and cons:

Pros:

- It’s a real return allocation.
- Diversification based on economic cycles and is future agnostic.
- Diversifies against non-spreadsheet risks.

Cons

- Doesn’t swing for the fences for returns.
- Will lag any single overweighted asset.

It’s a real-return allocation

Meaning it targets real returns over inflation (usually +3-6%) and has had a long track record of achieving that goal. A problem I see with stock/bond allocations is they can leave an investor with flat or even negative real returns for extended periods of time. For instance the 1970s were very bad for just about any stock/bond allocation. Most all I’ve looked at had serious problems with either 0% real or negative real returns over that decade. The 2000s were also very unfavorable to those allocations. But over rolling 10-year periods of time the Permanent Portfolio has not had protracted periods of these negative real returns.

Below are two charts from Simba’s spreadsheet illustrating this idea of the Permanent Portfolio vs. the standard 60/40 portfolio:

Permanent Portfolio Rolling Real Returns

60/40 Rolling Real Returns

The charts show:

1) During really good years the stock heavy portfolio turned in great real returns (1980-2000). Unfortunately, this is the biggest longest sustained bull market in U.S. history. It may repeat, but then again it might not.

2) The Permanent Portfolio had lower real returns during the heyday of stocks. But the returns are consistent through the entire time. The 60/40 portfolio you see had big problems with real returns in the 1970s and 2000s as discussed (negative or flat). The Permanent Portfolio fluctuated between that +3-6% real return range. So the overall returns are far more consistent.

Diversifies based on economic cycles and is future agnostic

Next, the portfolio chooses assets that are tied specifically to particular economic situations. Mostly, it works pretty well because there are just basic economic reasons why someone wants to own bonds (falling rates) and why someone wants to own stocks (a good outlook for the economy). I find this approach works much better to diversify against market risks than standard stock/bond allocations that rely on asset class correlations. I think that model of diversification is seriously broken and I don’t trust it. I discuss the basic problem with the entire idea in this post:

The Asset Class Correlation Model of Diversification Doesn’t Work

Also, the portfolio really is future agnostic. A stock heavy portfolio assumes that the stock market is going to win over an investor’s particular time horizon. However if you look at world markets (not just the U.S.) this is simply not true. Even in the U.S. the idea that stocks always win over time has been seriously challenged. I don’t think it is a very good assumption myself so I prefer to hold a more balanced portfolio and not make any assumptions about what will happen. Stocks are much riskier than given credit. IMO. They should be used in a balanced way.

Diversifies against non-spreadsheet risks

Spreadsheets miss a ton of risks that can show up over an investor’s lifetime. Things like Bernie Madoff, MF Global, real estate market panics, natural disasters, government interventions, etc. Think about investing for decades and everything that has or could happen going forward. The risks are limitless. So I think it’s a really great idea to diversify your assets even against things you believe are unthinkable. This means dividing up your money among more than one brokerage and even keeping some outside the country where you live.

Inside every paper currency there is an Argentina fighting to get out.

But you know some people think this stuff is paranoid and I get it. My views are colored very much by working in the unpredictable world of start-ups and doing a lot of world-travel (25+ countries at this point). I just got back from a trip to Argentina where inflation is perhaps 25%+ and where the currency exchangers (Travelex) won’t even buy Argentine Pesos back from you. I’m not saying that any country is going to go the route of Argentina, but I will simply say this:

Inside every paper currency there is an Argentina fighting to get out. 

Showing a red-hot CAGR in a spreadsheet backtest is pretty easy. I can do it right now. But there are other non-spreadsheet risks that I think investors should consider and the Permanent Portfolio does consider them as part of the model.

Now for the cons

First of all, the portfolio is not swinging for the fences for returns. I think people doing that approach are probably going to fail long term anyway because the volatility will wipe them out emotionally. Also I think that investors should take risks on their careers, and not with their life savings. I discuss this idea here:

Take Risks in Your Career Podcast

You can’t go back and re-earn the money you take huge gambles with in your portfolio. This risk gets incredibly higher the longer you go out on the timeline of life. Taking a big loss late in your investing career can be fatal. Even taking it mid-way can be a big problem because it could force you into a far too conservative allocation that won’t grow enough. I think the Permanent Portfolio has a great balance of growth with risk protection. This translates to investors being able to stick with the plan no matter what the markets are doing.

The next con is the Permanent Portfolio will lag any particular single asset you overweight. So if stocks are doing really well, you’ll hear everyone around you bragging about their hot returns when you have comparatively little. Of course the portfolio likely is beating inflation by a decent amount so you are doing OK, but you probably aren’t going to pull down 15%. Then again, you probably aren’t going to take a -30% hit either. Investors in the strategy need to simply accept that the portfolio is pretty boring and you won’t have much to talk about at cocktail parties. But personally, I want my life savings to be pretty boring so I’m OK with that.

I can probably add more, but you get the idea. The Permanent Portfolio is “best” for some people that want:

- Low volatility.
- Wide diversification.
- Likelihood of real returns.
- Protection against extreme events in the market.

If that’s what you want, it may be a good fit. In which case the Permanent Portfolio is really only going to be “best” depending on what you want for your investing goals.