Simplify Your Investing with the Permanent Portfolio

Simplify Your Investing with the Permanent Portfolio June 6, 2012

I’ve written about an easy way to become a millionaire before. With that method you need to have a long-term view to ride the occasional large losses along with the gains in the stock market – but it’s definitely a valid way to invest.

The challenge, however, is that a lot of people may not have the emotional strength to see their money go through such huge drops in value.

Does that describe you? Do you lose sleep at night when you see the value of your money taking a nose-dive? Does it cause you to worry?

If so, consider doing a portfolio analysis as well as an alternative strategy for long-term investing: the permanent portfolio. This strategy that may give you more peace of mind, as well as better returns.

The Permanent Portfolio

Harry Browne, a former presidential nominee and author of Fail-Safe Investing, identified four different assets that you could include in your portfolio, in equal proportions, on a permanent basis. He called the investment strategy the Permanent Portfolio.

Doing so would eliminate any guesswork regarding what asset to invest in, how much to invest in each asset, and – more importantly – prepare your money to handle whatever the economy throws your way.

What could the economy bring to pass? Browne identified that at any one time, the economy is in one of four basic phases.

4 Economic Phases

Prosperity

During prosperity, the economy is expanding and stock prices are rising. Businesses finance capital expenditures with debt, allowing them to grow faster.

This creates leverage, and stock prices rise faster than the underlying rate of economic expansion. So stocks do well during times of prosperity.

Recession

During recession, unemployment rises and stock prices fall. Cash is in short supply, so it becomes more valuable.

People sell their assets to raise cash, and those holding cash have the power to buy these assets at low prices. Cash acts as more of a buffer when the other three assets aren’t doing well, rather than a growth asset.

Inflation

During inflation, prices on all things rise – including gold. Because of rising prices, people look to trade currency for hard assets such as gold. As a result, the price of gold is pushed higher.

Deflation

During deflation, prices decrease. Interest rates fall, and pre-existing bonds with higher interest rates become more valuable.

The 4 Assets

To protect your money from the adverse effects of these phases, and even prosper in spite of them, Browne recommended investing in four assets, which I alluded to above: Stocks, Long-Term Government Bonds, Gold, and Cash.  Next to each category, you’ll see an example of a permanent portfolio ETF.

25% – Total Stock Market Index. You can own this asset through the Vanguard Total Stock Market ETF (VTI)

25% – Long-Term Government Bonds. You can own this asset through the iShares Barclays 20+ Year US Treasury Bond ETF (TLT)

25% – Gold. You can own this asset through the Central Gold-Trust (GTU)

25% – Cash. You can own this asset through the iShares Lehman 1-3 Year US Treasury Bond ETF (SHY)

If an asset falls below its 25% allocation, all you need to do is add more money to bring it back into balance.

Results

So how has the Permanent Portfolio performed in the past? Very well, actually.

From 1972 to 2008, the compound annual growth rate was 9.7%. Standard deviation, which is a measure of volatility, was 8.42%.

Compare this with investing in the S&P 500 during the same period. The compound annual growth rate slightly underperformed, at 9.51%. Volatility, however, was more than double the rate of the Permanent Portfolio – 18.65%.

In other words, if you started with $10,000 invested in the Permanent Portfolio at the beginning of 1972, you’d end up with $317,220 at the end of 2008. During this period, there were only two years in which the portfolio experienced a loss.

But if you invested $10,000 in the S&P 500 at the beginning of 1972, you’d only end up with $288,500 at the end of 2008. And during this period, there were nine years in which the portfolio experienced a loss.

In Closing

So not only would you have earned more money by investing using the Permanent Portfolio allocation, you also would’ve experienced less years where you lost huge amounts of money – something that should help you sleep better. Two nice benefits available to every investor – including you.

Do you invest using the Permanent Portfolio method?

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