The Permanent Portfolio, Investing, Finance and Random Thoughts.
Investing
Investing
Fake Gold?
5 months ago
An interesting discussion came up on the forums about spotting fake gold coins:
Verifying Gold Coins are Real?
I talked about this in the Gold FAQ but thought I will go over the points again here.
First of all, understand that as gold prices go up the incentive to make fake gold products goes along with it. With gold at very high prices today it is possible that fake gold products could start showing up.
In the FAQ I wrote I even link to a Chinese company that produces gold plated tungsten products that will have near the density of real gold and would likely fool traditional tests such as weight and dimensions:
This kind of product could likely fool many people unless they have access to specialized analysis equipment.
So what can you do to prevent buying fake gold bullion?
- Use a simple measuring device like the Fisch Tool, or a Gold Coin Balance. These tools check the dimensions of common coins and the weight. A fake coin will not likely have the density of real gold so it will be difficult to pass these quick checks. I have used the Fisch tool and it works quickly and efficiently but is expensive. The Gold Coin Balance tool looks new and I will test one soon, but the principle looks the same as the Fisch tool for significantly less money.
- Don’t buy any gold bullion off of places like E-Bay and definitely nothing out of Asia. E-Bay has many fraudulent items for sale (not just gold) and is basically full of con artists. Ordering gold out of places like Hong Kong or mainland China is just asking to get ripped off.
- Only buy from well established coin dealers (check the FAQ). It is unlikely these dealers are going to allow fake gold bullion to enter their inventory. This is another layer of protection for you and is worth the small premiums they charge.
- If a deal is too good to be true it probably is. Anyone selling gold for below market spot price is probably a con artist.
- Stick to well-known gold bullion coins like American Eagles, Canadian Maple Leafs or South African Krugerrands. They are well established and known by dealers who sell them.
- Don’t buy collectable coins or numismatic coins. There is more incentive to fake “rare” coins to sell to people that don’t know any better. Collectable coins are almost always a complete waste of money as they contain little precious metal content.
If you want to check your coins yourself you can get a digital scale and calipers and measure them using this table:
Fake gold coins are certainly possible, but not very likely if you follow the above advice.
Taking the Turns
In relation to yesterday’s post on portfolio firewalls, it reminded me of something…
I knew a guy that was a seasoned network architect. We were talking one day about network design and highest performance. Being young and dumb, I thought that highest performance was all that needed to be considered. He looked at me though and said:
“Speed is fine, just be sure you can take the turns.”
The point being that you can optimize for highest performance, but the reality of the world is you need to have proper fault tolerance, redundancy, etc. built into a design in case things don’t go according to plan. Speed is only one consideration.
Yet, the problem with many portfolio strategies is that they just can’t take the turns.
How do you get a portfolio that can take the turns? Here are my thoughts:
- Don’t fixate on backtested high performance numbers. They tell only one part of the story.
- Consider the worst case scenarios and imagine how your portfolio will react to them if they should happen.
- Complex portfolios (and complex trading strategies) are usually the result of people looking to get more speed. They have a lot of moving parts that can send you over a cliff in bad markets. Keep your portfolio as simple as possible to get the job done.
- Own assets from the four major asset classes (stocks, bonds, cash and gold) and don’t worry about slicing assets into tiny specialty sector pieces.
- Finally, investor emotions are a major factor in long term portfolio performance. Don’t underestimate the importance of a stable portfolio that can absorb bad market shocks or even prolonged bad markets. Even if that means giving up some theoretical (and that’s all it is) performance.
Investors often look so much at ultimate high speed performance and never consider what happens when things don’t go according to plan. Then they slam into the jersey wall when a hair pin turn shows up. Speed is fine, just make sure your life savings can take the turns.
A Portfolio with Firewalls
5 months ago
A firewall is something designed to contain severe damage of a house, building or car to only one portion. The idea is if a fire breaks out it can be easily contained and the damage cannot spread to cause severe catastrophe. In a modern townhouse you have firewalls in case your neighbor’s place goes up in flames. In buildings you have firewalls to keep fire from spreading quickly across a floor. In a car you have a firewall that separates the engine from the passenger compartment. It’s good design strategy to build in fail-safes like firewalls in case something happens you didn’t expect.
But did you know that the Permanent Portfolio has firewalls built-in? Yep, it does.
By limiting each asset class to an initial 25% allocation (Stocks, Bonds, Cash and Gold) any one of them can take a large loss and the portfolio damage is greatly contained.
The recent media darling has been gold. The Permanent Portfolio has gathered quite a bit of publicity because it holds gold and of course the critics point out how gold can crash at any moment. And, I agree it could. Which is of course why these pages have encouraged investors to stick to their rebalancing bands for all their assets all the time and not try to predict the market.
But what if? What if gold crashed by -50% tomorrow morning? It could happen. But -50% of a 25% allocation to gold is a -12.5% loss to the entire portfolio value (remember, only total portfolio value matters). That’s not great, but it’s not a disaster (compare that to the massive losses stock investors took in 2008 for instance). This also of course assumes no other asset like the stocks or bonds goes up in value in response to cushion the impact.
So how is this a firewall? It’s a firewall because the portfolio design doesn’t allow you to concentrate your bets. Many other strategies advocate asset class timing, adjusting stock allocations based on age, concentrating bets based on historical performance expectations, etc. These approaches allow investors to build up large single asset class positions that are ripe for the picking in a bad market. The Permanent Portfolio however advocates never letting any asset get higher than 35% in value and never lower than 15% in value. It is forcing investors to sell down winners when they are doing well and buy the losers when nobody wants them. And if an asset is somewhere in the middle? Well it keeps severe damage from ravaging your life savings because no asset is so concentrated as to cause a large loss. Simple.
But we still hear the complaints about holding 25% in gold. Ok I see the same things everyone else does about gold but I still advocate people stick to the plan. Frankly I’ve been hearing about gold’s impending doom since it was $600 an ounce and now it’s $1800.
So what if gold nosedives -50%? Will you really take the -12.5% loss? Probably not. Or at least not for very long. What the critics seem to overlook is that the Permanent Portfolio also holds stocks, bonds and cash. Investors taking their money out of gold are likely going to put it into one of these other places. Cash of course won’t appreciate much, but if the gold sellers decide to buy bonds or stocks the prices will soar and the value of the total portfolio (remember, that’s what we care about) will not be affected much. Or, it may actually post a gain in a gold market crash (this has happened in the past). This is just how the markets work. And, if we think about it, we’d probably realize it makes sense unless of course those investors take that money from the gold sale and shove it under their mattress which is unlikely.
A period where your stocks, bonds and gold are all going down together is possible, but just not very likely long-term. Nature abhors a vacuum and the markets do as well. That money from a big gold sell-off is going to go somewhere and chances are it’s into an asset class you already own. Just as it happened in 2008 when the stock market collapsed and the money flowed into bonds. In that case the stock firewall limited losses to that area and the other assets were there to soak up the capital as it fled.
While there is no way for us to predict the future, we can try to design a portfolio that has firewalls in place to mitigate potential disasters in any one asset. I’ve looked at a lot of portfolio designs and the Permanent Portfolio is the only one I’ve ever seen that builds this concept into the core strategy. Harry Browne was, once again, way ahead of his time.
Stop Losses and the Permanent Portfolio
5 months ago
Someone wanted to know if using stop losses is a good idea for the Permanent Portfolio. In short, no they aren’t.
For the uninitiated, a stop loss is an automatic order in place at the broker to sell a security when a certain low price has been reached. The theory is that you can set a stock price that is, say, 20% below your purchase price and if the stock drops to that level it is sold automatically. The idea is it limits your losses in any one position.
Sounds good in theory. Yet in practice it has the following issues:
Whipsaws – This is a fancy way of saying that you could sell out of a position automatically only to see the price recover almost as fast. For instance, a price could drop suddenly on bad news one day but as the markets digest the information the price could quickly recover. This happens frequently in the markets. This is a very bad thing in a taxable account because it can drop a tax bill in your lap if you just happen to lock in some gains in that position.
Delayed Order Execution – In a large and fast market drop your order is not executed immediately. It will be executed when many other orders are flooding in and you will get the market price. So you may set your stop loss at $15 per share for instance, but your order may execute at the $10 price. If the stock recovers even to $15 at this point you’ve taken a serious bath vs. just leaving things alone.
Automates Bad Portfolio Management – When you automate sales in your portfolio it takes away what is frequently your best option during a volatile market: Doing nothing. I’ve made a ton of money by just ignoring market goings on and sticking to my plan. Doing nothing is a big part of successful investing.
Makes Panicking Easier – When the stop losses kick in it is easy to go into panic mode. You now have this bundle of cash sitting there that this circuit breaker has thrown into your lap. Now you have an awful decision to make:
- Do I keep it out or get back in?
Then you have the second awful decision to make:
- Is it too expensive to get back in now or do I wait a little longer and see if it drops more?
Then you have the third awful decision to make:
- I knew I was too early because the price just dropped when I bought back in. Should I sell out again or leave it alone?
Why torture yourself repeatedly with this cycle? Not just this, but it’s never a good idea to react in a panic and stop losses force you to react right when it’s usually the worst time (in a panic).
Finally the above isn’t just theory. In 1987 we had a 25% market decline that caused a huge sell-off. Yet by the end of the year the stock market was in positive territory. Selling out during the panic was not a good idea. And more recently in 2010 we had the Flash Crash where the market dropped nine percent in a few minutes, but then snapped back within minutes after. A stop loss there would have resulted in almost certain losses.
The best way to manage risk in the Permanent Portfolio is to use rebalancing bands and avoid any kind of automated trading. Orderly rebalancing will not only likely result in better performance, but will be much better for your sanity.
Rebalancing Spreadsheet
6 months ago
Just thought I’d post a link to a rebalancing spreadsheet I’ve used for some time now from www.flexibleretirementplanner.com:
The spreadsheet needs a couple small things to get working. The main thing is to erase the data in the Imported Data tab. Then, fill out the Imported Data tab with your Permanent Portfolio asset class names along with the cost basis and current market value. For example:
Vanguard Total Stock Market $xxxx $yyyy
US Treasury Long Term Bonds $xxxx $yyyy
Gold Bullion $xxxx $yyyy
Treasury Money Market $xxxx $yyyy
Next up is to go to the Asset Class Info tab. On the bottom table you want to delete the security names that are listed under the Security Table. Then go into the Asset Class 1 column and blank out the asset class types. Next, put in the asset class names exactly as typed them on the Imported Data tab. In the Asset Class 1 column select the name of the asset class that best defines what you are using. For instance for my Vanguard Total Stock Market index I just selected “Lg Cap Blend.” For the bonds select “Domestic Bonds.” For your Treasury Money Market select “Cash.” For the Gold select “Gold.” If you did this right, the current value you typed into the previous tab will be copied over, if not you will get an Not Found message. Check for typos if this happens.
Then, go to the Rebalance tab. Type in “0″ in each column entry under Target Percent to blank everything out. Then go to each asset class label (Lg Cap Blend, Domestic Bonds, Gold, Cash) and put in your desired percent holding. In the case of the Permanent Portfolio you put in 25% next to Lg Cap Blend, Domestic Bonds, Cash and Gold. You will see the figures you entered into the Imported Tab be magically copied into the spreadsheet. The target amount figure should match the portfolio values you entered in the Imported Data tab.
Finally, go to the top left box and look for Trigger Factor. This is the value where if the asset class has shifted up or down too much the spreadsheet will tell you how much you need to buy or sell to bring it back into alignment. You can try setting it between 20-30% for your rebalancing bands.
Now when you need to see if and how much to rebalance you simply update the current market values in the Imported Data tab and the figures are done for you. You can also play around with the parameters on the spreadsheet to test out various doomsday scenarios for your allocation. But be careful not to alter the formulas.
Enjoy.
