What was this stuff I kept hearing last year about the dollar crashing? In December 2009 this talk reached a fevered pitch. Here’s the dollar index over the last year and you can see how much it’s recovered since the dark days of December 2009:

You can track the US Dollar index at this link.

Since this time the Euro has taken a pounding due to the issues with Greece possibly going into sovereign default. This drove the Euro down and the Dollar was the beneficiary. I’m not a dollar bull necessarily, but I post this just to show (yet again) that reacting to news that everyone else already knows is rarely a good way to invest. The markets are random and things we think must happen may not happen for a very long time (if at all).

Best to ignore all of the financial news and just stick to a simple diversified portfolio that can take care of you whether the dollar is sinking or flying.

If you’re in the investing world long enough, you’ll eventually get tempted to put your money into some new investment or try to tweak your portfolio to outperform the market. It’s easy to get lulled into an idea that you can beat the markets if you just do enough research, just make enough trades, just own the right funds, just follow the right market prognosticator, etc. But what you’re really doing when you try to beat the markets is moving from the realm of investing to speculating. And when you speculate, you take the chance you may beat the markets, but you also take the chance that you may not.

So in this vein, I went back and found a short segment of what I feel is one of the core ideas behind the Permanent Portfolio from Harry Browne himself. I think this little two minute clip captures a fundamental truth in the investing world about why you need to be skeptical and why you should understand the differences between investing and speculating:

Harry Browne the Skeptical Investor

This clip was taken from Harry Browne’s radio show on October 31, 2004.

Harry Browne and Terry Coxon formally introduced the Permanent Portfolio in their 1981 book entitled: Inflation Proofing Your Investments. Like most great ideas, the Permanent Portfolio was simple, but was not simplistic.

The Permanent Portfolio investment strategy is the first one I’ve seen that developed an allocation based on economic cycle analysis. The Permanent Portfolio idea separated these economic cycles into four basic categories:

1. Prosperity
2. Inflation
3. Deflation
4. Recession

At any one time the economy will be in one of these phases or transitioning from one phase to another. This is the secret of the strategy and why it works. The strategy does not attempt to predict when these things happen or guess how long they may last. Instead, it holds specifically chosen asset classes that respond well to these cycles no matter when they happen or for how long. 

By 1987, Harry Browne took the more complicated asset allocation presented in his and Coxon’s first book above and refined it to make it easier to implement. This version of the allocation was presented in his book Why The Best Laid Investment Plans Usually Go Wrong (Find a used copy if you can. Like all of Browne’s books, it’s a must read.). The allocation remained the same in all his investing books that followed. Here it is (Preferred investment vehicle in parentheses):

• 25% – Stocks (S&P 500 Stock Index Fund)
• 25% – Long Term Bonds (US Treasury 30 Year Bonds)
• 25% – Gold (Physical Gold Bullion)
• 25% – Cash (Treasury Money Market Fund)

These assets are always present in the portfolio in a balanced way no matter what is going on in the economy. Why were these assets chosen? Because they respond to the four economic cycles listed above:

• Stocks – During prosperity, stock Index funds capture the full market returns available.
• Long Term Bonds – During times of deflation, US Treasury long term bond prices will go up quickly in value. Bonds also do reasonably well during prosperity. 
• Gold – During bad inflation, gold bullion is the only asset that provides strong protection against a falling currency. 
• Cash – During a recession, no particular asset class is going to do well. The cash in a Treasury Money Market Fund acts as a buffer for losses while the markets adjust during these relatively short times of underperformance. It also does well during deflation. 

Remarkably, these four asset classes are all you need to handle good and bad markets. Again, it’s simple but not simplistic. 

Even better, this allocation provides safe growth of your money. This means you won’t have to worry about the crazy swings in the stock market that may cause large losses of your life savings.

In fact, over the 30+ year history of this portfolio strategy the worst loss it ever had was about 4-6% in 1981 with an annual growth of 9-10% since 1972. The portfolio has prospered and protected its money through bear and bull markets alike. 

What this means is the Permanent Portfolio strategy will move along through the years providing stable and secure growth. 

How stable and secure? We’ll talk about that in my next post. But I feel if you combine the Permanent Portfolio with the 16 Golden Rules of Financial Safety you will have a very solid investing foundation that will get you to your ultimate destination in one piece. 

In the meantime, if you haven’t purchased a copy of Fail-Safe Investing you should really consider doing so. This book explains the method to the strategy in a very easy to read and understand form. My postings here will clarify some common questions, provide you with insight into ways to implement the ideas, and delve deeper into the economic mechanisms that make the portfolio work. 

Harry Browne also discussed the Permanent Portfolio Allocation in this radio show link.

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

An article in Forbes magazine tries to make the case for devaluing the dollar by 40% to help out the economy:

Why not attack the situation in a manner that will benefit most everyone, an approach that has been successful before and, when compared to the current course, has little downside? Here it is. Stand back. World currencies should be devalued overnight.

The Forbes article is riddled with errors about inflation and the gold standard that I won’t address in this post. The short of it is that devaluing the dollar by 40% won’t do anything at all except force the prices of everything else in the market up by 40% overnight as businesses move to protect themselves. It would also drive interest rates on loans through the roof, put many companies into bankruptcy, wipe out huge portions of savings of the average American and make a bad economy much, much worse. 

So what if? After all, this is Forbes Magazine discussing the idea so someone thinks it’s good. How would you want to position your finances if the threat of a massive inflation to solve our problems came to pass? 

For severe inflation you want to be in gold, commodities, and other tangible assets. Real estate may also be another option, but is not a very liquid investment which causes its own problems. 

You want to be out of long and intermediate term bonds and cash which will rapidly lose value. In the long-run stocks should beat inflation. However, in the short-run stocks will do poorly during high inflation as businesses have a hard time adjusting to rapidly increasing prices. Short term government bonds and money market funds may tread water OK but won’t be profitable. Treasury Inflation Protected Securities (TIPS) may also tread water again without much profit. Then again, risks could show up in this situation that would even effect these bond holders dramatically. 

The true worst-case inflation scenarios includes things like price, wage, capital and exchange controls which always are tried when governments are scrambling to prop up their currencies. These actions are all tremendously bad news for an economy. If you ever hear high-ranking politicians openly talking about doing such things you should be prepared to move quickly to protect your money by shifting it into tangible goods, hard assets, or moving it into another currency (preferably in a foreign bank) if possible. Even this is not foolproof as governments would likely put up blockades to trap as many people as possible before a serious devaluation would occur. 

But this is all worst-case scenario. Does it happen in real life? 

Well, in Argentina before they devalued the peso in 2001 they implemented capital and exchange controls. These controls forced citizens to repatriate foreign funds, froze all bank accounts, limited how much money could be removed at any one time, and converted all domestically held accounts in Euros and Dollars into the Peso before they did the devaluation. The Argentinean peso lost about 80% of its value shortly thereafter, decimating the life savings of their citizens. Nice huh? 

Just because the US Dollar is the reserve currency doesn’t rule out the use of high inflation to try to solve economic problems either. The question is, can it happen here? Well, it almost did. The decade of the 1970′s wasn’t bad just because of Disco. It also saw double digit inflation with the prime rate over 20% by 1980. It also saw price and wage controls, shortages of oil and other staples due to these controls, and a destruction in the standard of living for working and retired Americans on fixed income as the value of the dollar sank by 50%. So this type of scenario has happened even in the US and was only averted after a very painful recession that capped off 15 years of flat stock market returns. The next time it occurs we may not be so lucky.

This is all an extreme situation, but it’s always a good idea to consider how to deal with problems you think are unlikely right now. For this reason, I think all investment portfolios should hold some percentage of their allocation in hard assets as insurance in case a bad inflationary situation unfolds. More on that in the future.