The Permanent Portfolio

by Michael Batnick, The Irrelevant Investor

For the last 35 years, the classic 60/40 portfolio returned 10.5% a year. Itā€™s hard to imagine that these results will be matched over the next 35 years, which has a lot of people looking to alternative ways of managing a portfolio. Today Iā€™m going to examine one of these alternatives, the ā€œPermanent Portfolio,ā€ which was outlined in William Bernsteinā€™s ā€œDeep Riskā€ (and elsewhere). The Permanent Portfolio consists of 25% of each of the following:

  • U.S. Stocks (S&P 500)
  • Cash (One-month t-bills)
  • Long-Term Government Bonds
  • Gold

Letā€™s get this out of the way early- these results are hypothetical. For one thing, they assume no transaction costs. Also, before the advent of GLD, retail investors were only able to purchase Gold at a significant markup. If you can accept this and not rip your hair out, letā€™s proceed.

Below is the growth of $1 since 1976. The 60/40 portfolio compounded at 10.13% for a total return of 5,050%. The permanent portfolio compounded at 8.4% for a total return of 2,600%.

1While the permanent portfolio did not keep pace with either stocks or a 60/40 portfolio, which is to be expected, the ride was much smoother. The standard deviation of returns was 14.9 for stocks, 9.6 for a 60/40 portfolio, and just 7.2 for the Permanent Portfolio.

4The biggest appeal for somebody who would choose the Permanent Portfolio are the drawdowns, which were much more shallow than the 60/40 portfolio. In October 1987, the Permanent Portfolio fell just 4.5% while the 60/40 portfolio fell 13.4%. After the tech bubble burst, the deepest drawdown for the Permanent Portfolio was just 5%. Stocks got cut in half and the 60/40 portfolio declined as much as 21%. Ā In the aftermath of the financial crisis, the worst it got for the Permanent Portfolio was -13%; the 60/40 portfolio fell more than 30%.

2The benefits of the Permanent Portfolio are pretty clear, but the biggest challenge I see are the mental and emotional peaks and valleys. Below is the difference between the Permanent Portfolio and the S&P 500 over twelve month periods. Green is when the Permanent Portfolio outperformed and red is when it underperformed. Ā Stocks might not be the appropriate comparison, but Iā€™m using them because they represent regret, or what ā€œcould have been.ā€

3The permanent portfolio has an us vs them mentality and when ā€œtheyā€™reā€ winning, it can take a real toll on your psyche. Iā€™m not suggesting itā€™s easy to stay in stocks as theyā€™re falling 20%, 30%, 40% and more, but there is something incredibly true about the phrase ā€œmisery loves company.ā€ I canā€™t prove this, but Iā€™d imagine itā€™s more difficult to go through prolonged periods of underperformance while the rest of the world is singing Kumbaya than it is to stay in stocks through a bear market. In the three years from March 1995-March 1998, the S&P 500 rose 134% while the Permanent Portfolio rose just 36%. It would have taken an almost inhuman amount of discipline to have stayed the course.

I have little bad to say about the actual construction of the Permanent Portfolio; I can think of far worse ways to manage your money. The biggest potential problem is that sitting through underperformance is very difficult, which is obviously true of anything other than a plain-vanilla index. But if you think youā€™re able to stay invested in this model through thick and thin than youā€™d find yourself far ahead of most investors out there.

Source:

Deep Risk

Copyright Ā© The Irrelevant Investor

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