In recent months I have been getting more and more questions about permanent portfolio models. There are too many of them to go through at the same time but the majority is based on similar fundamentals.

The basic rule of a permanent portfolio is that our capital is spread among 2-4 groups of assets. When the price of one asset rises and the other is getting cheaper their share of our portfolio changes automatically. At the end of the year the portfolio is corrected to set the share of each asset group back to the baseline. Thanks to that we capitalise on assets that got relatively expensive, meanwhile buying a discounted group.

Benjamin Graham – the Pioneer

Source: Self-made

The pioneer of a permanent portfolio model – Benjamin Graham – is a mentor of the well-known Warren Buffet. Due to the fact that Graham worked with financial markets over 50 years ago his portfolio consisted exclusively of stocks and bonds in a 50/50 ratio. Managing such a wallet was very easy. When there was a boom in the stock market and bears were looking at bonds, Graham sold part of his shares and bought bonds. While very simple, it generated a significant profit from his investment.

 

Harry Browne’s Model


Source: Self-made

Basing on the Graham’s strategy, new models evolved. Harry Browne’s model got very popular. It was based on 4 pillars: stocks, bonds, gold and cash. Since 1971 to 2012 this model gave an average annual profit of 9.6%. The best feature of it was not the scale of returns but its stability and predictability.

Throughout 41 years this wallet yielded returns between 6-15%. Worth noting is that Browne’s strategy recorded a loss only in 3 years, with the highest one being at merely 4%.

Source: Self-made

You can see above how each of the assets used were performing until 2012. Prices of stocks and gold changed many times and they did so sharply. Throughout the 70’s gold was the winner of this race. Stocks visibly dominated during the 90’s. The part of the portfolio that failed expectations was cash – namely the short-term deposits.

Permanent Portfolio Model with no cash

Source: Self-made

Those investors who understand how dangerous in the long-term is keeping 25% of their portfolio in cash, decided to exclude it from their wallets.

This rendered two results. Firstly, it increased profit form 9.6% to 10.36% per year. This may not seem like much but after four decades an investment of 10 000 USD made 570 000 USD. This makes a big difference.

Compared to the wallet containing cash – it generated 410 000 USD. Even a small percentage change means a lot in the big picture. Here it meant 160 000 USD.

Secondly, as profitability increased the volatility also rose. This wallet had 5 years when it was in the red (instead of just 4 years), which still is a satisfying result throughout 41 years. The biggest annual loss was 11%. This worked both ways, making revenue in some years bigger than in the traditional model.

The key fact is that the model without cash was the first one to break the record level of return on investment from 100% stock wallet. This way the long-term return was coupled with a low volatility.

Source: Self made

Marc Faber’s Model

Source: Self-made

Faber’s model was the first to include a real estate into the portfolio. Rental residential properties were one of four asset groups among stocks, bonds and gold. Each 25%.

The inclusion of real estate opened portfolio for a very profitable sector but did not disturb a long-term volatility since properties are not as volatile as, for example, stock prices.

You can design many types of portfolios but the most important fact is, that Faber’s wallet generated the highest ROI of any other models.

You can see in the above chart that in 41 years a traditional permanent model gave attractive ROI but paled when compared to others. Among many competing strategies Faber’s one gave the best results. The absolute leader was El-Erian, the former CEO Pimco, but his model is much harder to manage than the rest.

Summary

Permanent portfolio models seem to be easy to manage. After their creation the only thing we should do is to correct the shares of our assets once per year. In a nearly automatic manner – we sell expensive assets and buy cheap ones. What I want to highlight once more is the simplicity of those models. Many less experienced investors will save a lot of nerves due to a lower volatility of those schemes compared to an investment in stocks.

What used to be great for many decades may not be adequate today. I can understand investing in gold, real estate or stocks but bonds with today’s prices and yield amounts to a simple guarantee of a loss. Holding money in our circumstances makes sense. When few decades ago models of permanent portfolios were created no one could have thought that because of central banks’ interventions insolvent governments would ask to pay them for the ‘privilege’ of lending them money.

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