The Permanent Portfolio allocation sometimes gets criticized for not following standard investing dogma. One critic stated:

Why not wonder why none of the financial authors or academics endorse it?

Because they’re too busy defending their own pet portfolios and theories. I’ve seen plenty of bad advice from financial authors and academics. And the thing is, they will never admit they are wrong no matter how much money they lose for people who listen to them.

In fact, last year I disposed of a pile of investment books that were chock full of bad advice. They were going to the recycler because I felt it better they be turned into toilet paper than have them wreck the hard earned savings of someone who happened to read them. 

Fundmentally I’m an index fund investor. Harry Browne’s advice has many aspects to it that differ somewhat with what many people read from other index fund authors and academics:

1. He advocates fixed allocation percentages with rebalancing bands instead of altering stock/bond mix as one ages. 
2. He advocates using gold in the portfolio for inflation protection instead of Treasury Inflation Protected Securities (TIPS). 
3. He advocates using Treasury Long Term bonds in the portfolio instead of short/intermediate bonds or the Total Bond Market index.
4. He advocates only holding US Treasury bonds to avoid credit risk.
5. He advocates holding a good amount of funds in cash to buffer during recessions. 

However there are similarities with what many index fund authors and academics state:

1. He advises using only index funds for the stock allocation.
2. He advises to never try to time the markets.
3. He advises that the future is unpredictable and you should ignore market prognosticators.
4. He advises to “stay the course” and stick to your rebalancing bands no matter what you think may happen in the markets.
5. He advises to have an investment plan so you can deal with market uncertainty and not have your money run your life because you are worrying about it all the time. 

Overall I’ve never seen anything in Harry Browne’s advice that I would call “bad”. His advice may be conservative, but it’s not going to get someone into big trouble.

When I read posts on the Internet that criticize Harry Browne and the Permanent Portfolio I have to ask why? Because he was right? Because he advocated a portfolio allocation for many years that was basically unchanged? Because he allowed people to invest and earn acceptable returns with low risk? Because gold sometimes outperforms stocks in a diversified portfolio when academic theory says it shouldn’t? Because people who took credit risk on their bonds instead of owning Treasuries weren’t rewarded as they thought they should be? Because a portfolio that equally weights different assets can match the returns of a conventional stock-heavy allocation with significantly less risk and volatility? 

Their criticisms basically amount to: “I don’t care that the portfolio allocation works. All I know is that these academics and authors say it shouldn’t, therefore it’s bad.”

Sounds like sour grapes to me.

UPDATED: This posting now lists (mostly) finalized 2008 total returns information (interest and dividends included) from the listed stock indices. The final numbers won’t change much. 

“The best kept secret in the investing world: Almost nothing turns out as expected.”

– Harry Browne 

Investors won’t be forgetting 2008 any time soon. Yet as bad as it was, the Permanent Portfolio survived intact with a profit for the year of about two percent.

The year included oil and other commodities going to record highs. Real estate prices fell at a rate not seen since the Great Depression. Century old banks that were leveraged to their eyeballs blew up and vanished. Iceland, a first-world country, went broke. Bernard Madoff, one of the founders of NASDAQ, admitted his hedge fund was a $50 Billion Ponzi Scheme. The Treasury Secretary and Fed Chairman openly talked about The End of The World As We Know It if we don’t “do something”. That “something” of course meant big bailouts for banks, irresponsible home buyers and automakers (and maybe more — to be continued).

By the time 2008 was over, the markets were down by one of the largest single year amounts since 1931. 

Performance Results

The results were brutal for investors in many commonly used asset classes. The numbers below include interest and dividend total returns from Morningstar:

S&P 500 -37.22%

Total Stock Market Index -36.67%

EAFE International Index -41.04%

Emerging Market Index -48.89%

Commodities Index -31.73%

Real Estate Investment Trust Index  -41.01%

High Yield Bonds -17.98%

Emerging Market Bonds  -10.29%

Treasury Inflation Protected (TIPS) Bonds -2.85%

Corporate Bonds  +2.02

International Bonds  +2.41%

Total Bond Market +5.13%

As the markets roiled the Permanent Portfolio bobbed and weaved and avoided a knockout. Here’s the breakdown of the results using commonly available ETFs and physical gold price to make up the Permanent Portfolio Allocation:

25% Vanguard Total Stock Market ETF (Ticker: VTI) -36.68%

25% iShares 1-3 Year Short Term Treasury Bond ETF (Ticker: SHY) +6.19%

25% iShares 20+ Year Long Term Treasury Bond ETF (Ticker: TLT) +33.46%

25% Gold Price appreciation for the year +4.92%

2008 End of Year Result: +1.97%

NOTE: If you used the standard Permanent Portfolio “Cash” allocation of Treasury Money Market instead of Short Term Treasury Bonds that asset is up +2.71% for the year bringing to total portfolio result to +1.10%

The best managed mutual funds (and Ivy League Endowments) in the world are down 25, 30, 40, or more than 50% in 2008. The fact that the Permanent Portfolio allocation allowed you avoid big losses in such a bad market is great and gives you a good leg up if the markets recover next year. 

Ups and Downs of 2008 Produce an Unlikely Winner

This year started off in inflation and ended in deflation. The first half saw the price of gold up 20-30% higher than it is today reaching an all time high of over $1000 an ounce (not adjusted for inflation). But by October things started to change. Gold was below where it started for the year and the stock market, which had been slowly sliding, began to really plunge. By the end of the month the damage was tremendous for investors. 

Also this year credit risk showed up in unpredictable ways. Investors who owned speculative bonds and other supposedly “safe” assets that promised higher than market returns learned first-hand that  there is no free lunch in investing . 

The winning asset this year was a surprise to just about everyone: Treasury Long Term Bonds. This stodgy asset racked up gains around 30% in a little over a month and wiped out almost all the losses in our stock holdings. This is a remarkable feat considering just months earlier all available inflation indicators were climbing at a brisk pace which is bad news for bonds. Who says bonds are boring? 

I can’t think of one prominent investing talking head or market prognosticator who was forecasting Long Term bonds were going to be the winner in 2008. Can you? 

A Theory Proven

When the Permanent Portfolio was designed, the creators based it on responding to economic cycles of prosperity, inflation, recession and deflation. Up to this point, the portfolio has endured good prosperity, bad inflation and bad recessions and has grown safely and securely. The only economic cycle it had never been through was deflation which hadn’t been a serious threat since the 1930′s Great Depression.

Well I’m happy to report that 2008 has shown the deflation protection works. While we don’t know what 2009 may bring, we now know that the portfolio weathered all economic threats it was designed to handle so far.

The Permanent Portfolio is now a veteran of all of these scenarios and came out with solid returns and excellent downside protection in turbulent markets. The portfolio helped to preserve its capital which is now available to rebalance back into stocks to take advantage of any gains that may show up going forward. 

Time to Rebalance?

One last thing: Have you rebalanced yet to harvest your gains and buy your losers? You should really think about doing that if you need to. 

Gratitude

Thank you Harry Browne, Terry Coxon and John Chandler for all the work and research you did into this investment strategy over the years. A special thanks to John Chandler who still hosts Money Talk and is keeping Harry Browne’s message of the balanced Permanent Portfolio alive (get his podcast here).  You’ve allowed many people to invest safely and sleep well at night.

Let’s hope that 2009 is kinder to investors than 2008. Happy New Year!

Buy the book and learn to make your own Permanent Portfolio. It’s the best ten bucks you’ll ever spend:

Fail-Safe Investing

The investing world is full of advice. Some good. Most bad. Stocks, bonds, cash, 401(k), IRA, etc. Up is down. Left is right. And if you only follow the right sage advice you can become an instant millionaire. It’s all too complicated isn’t it? Well, the fact is that investing can be easy and profitable if you avoid the major pitfalls that stalk every investor.

When I first started investing I was drawn into the circus of the stock markets. Educated analysts, sophisticated computer models and wise money managers were advertised as the keys to success. The brochures showed retired couples walking on a sunny beach into the sunset (presumably after they just got off their yacht). Marketers trumped up the past returns of their funds and how much money you would have made if you were smart enough to have invested back then. Yet, the results just weren’t there. Sure, there were some mutual funds that did fine from time to time but it was never consistent. Money would be made, and then unmade, just as fast. 

Like many, I invested through the tech boom of the late 90′s only to see much of what I earned evaporate. Remember those days of analysts hocking the IPO of companies like furniture.com? How could that fail! When you want a sofa everyone knows the best way to get it is to order it off the web and have UPS drop it off on your doorstep, right? 

Well we all know how that turned out. In fact, for completely unrelated reasons, I was lucky in that I managed to sell out of the markets while the damage was simply horrible, but not yet terminal. Others I knew weren’t as lucky. 

When I started saving and investing again I had to find a better way. During this time I came across index fund investing and began to travel down the road of enlightenment. Index funds always gave you market returns guaranteed (good or bad). They avoided the bad decisions that fund managers made trying to get big returns. They had low costs. They were simple. They worked, and served me well for many years. 

Yet, by 2006 I had some concerns. My study of economics and history showed that there are times, many times, when things don’t go according to plan. This is the normal state of the world. It was these uncertain times that presented problems for standard stock and bond allocations – problems that could lead to serious consequences. While stocks have long stretches when they do very well, there were also long stretches where they did poorly. Bonds had similar issues. Even worse, sometimes stocks and bonds would do poorly together. So, I went out to look for something that would distribute my risks better than what stocks and bonds could alone.  

Enter Harry Browne (who passed away in 2006). I won’t go into Mr. Browne’s background now except to say he was a two time Libertarian presidential candidate and best-selling financial writer. I found his book Fail-Safe Investing by accident (I don’t even remember how I came across it actually) and he introduced me to his idea of a Permanent Portfolio (co-created with Terry Coxon in the late 1970s). His portfolio held stocks, bonds, gold and cash at all times in fixed allocations. It was unconventional, but he had a strong case for why it worked. 

I eventually came around to his way of thinking as I did more research. The basic ideas behind the Permanent Portfolio are:

1) The portfolio should provide wide and true diversification.

2) The portfolio should be simple and not require a lot of maintenance or monitoring. 

3) The portfolio should allow you to grow and protect your money no matter what happens. 

The portfolio follows what Harry Browne called his “16 Golden Rules of Financial Safety” which are the core principles of his investing philosophy that have proven to be very wise advice over the years. 

After much research and reading I came to use the Permanent Portfolio concept for my own investment needs. In future posts, I’m going to explain how you can use it too. In the meantime, I recommend purchasing his e-book Fail-Safe Investing (I have no financial affiliation with the estate of Harry Browne). It will be a quick read and could be the best money you spent in a long time if you are ready to get a handle on your investments. 

Fail-Safe Investing