Bogleheads

[AndromedaAsc]

Ok there's one thing I don't get about PP.

Why does one need to hold cash/short-term bonds during for deflation? 25% in cash is really undesirable, and even assuming one replace cash with short-term bonds, that's 50% in bonds, which is far too conservative for a young (mid 20s investor). Can there be room for adjustment? Personally, I was thinking more of 25% Bonds, 50% Equity and 25% Gold + Commodities. Does that make sense in terms of the PP philosophy?

My designed allocation for a revised PP would be something like
25% for Inflation
12.5% Gold
12.5% Commodities (e.g. DBC)
25% for Bonds (Bear Market)
7.5% US Long-Term Bonds (20-30yrs)
7.5% US Short-Term Bonds (1-5yrs) - I suppose this can be the "cash" equivalent in my portfolio
10% Foreign Intermediate/Long-Term Bonds (5-10yrs)
50% for Equity (Bull Market)
15% US Stock
15% Europe-Pacific Stock
15% Emerging Stock
5% Global REIT (about 1:1:1 for US:EU:Asia)

Some comments:
1) I halved Gold allocation and gave it to a diversified commodities ETF. Maybe I'm being emotional but 25% in gold is a bit high... will diversifying it out to commodities serve the same overall function? As commodities are real asset won't they also help during periods of hyperinflation or periods of economic frenzy?.
2) You may have noted that US-based stock and bonds make up ~40% of my portfolio. That is intentional. For e.g. if an Iceland-scenario would to happen, only 40% of my wealth will be lost; here I'm assuming total economic collapse/bankruptcy of the nation not just a bad bear market. Of course, I'm also assuming EU and Asia will still survive in the process.
3) I don't use TIPS as I think they will not stand up well under hyperinflation or pseudo-hyperinflation conditions. I use gold and commodities for this.

Also, I'm having trouble understanding why is deflation bad for us? If during deflation my money gets more valuable, shouldn't I be happier? I mean we all have reasons to fear inflation and hyperinflation, but why should we protect ourselves from deflation?

[MediumTex]

[Roy]

[AndromedaAsc]

[quote="MediumTex"]

[MediumTex]

[raddle]

[craigr]

[macclary]

"Why does one need to hold cash/short-term bonds during for deflation?" Cash is actually meant to provide liquidity during recessions. This means that you won't have to sell other parts of the portfolio when prices are depressed, and you can re-balance your cash into the assets that are on sale. Cash should hold up well during a deflation but the long bonds are the segment that is really supposed to perform during deflation.

"that's 50% in bonds, which is far too conservative for a young (mid 20s investor)?" This statement is not supported by science. For example see Roy's comments on the advantages of any "low beta" portfolios in general. There are four reasons that this misconception exists: 1) One is that mean-variance optimization tends to put too much weight in risky assets because of the difference between arithmetic and geometric returns. 2) The risk of owning stocks is assumed to go down with time, but research has shown that the chance of holding through a major crash also goes up the longer you hold and largely balances out. 3) Even if the risk/reward promise was honored by 80/20 type portfolios - this advice is right for almost no one in the general population because the pain of the intermediary losses is just too high and people sell. 4) The high volatility of the portfolio means that the decision to put money in or take money out during life events has very high consequences of mis-timing.

I don't want to discourage you from trying out different portfolio ideas. I think if you spend time understanding why the PP works it will help you when thinking about new portfolio ideas. Previously suggested allocation:

Portfolio Allocation: 15.0% MKT-TSM , 15.0% EM , 12.5% GOLD , 12.5% COMM , 10.0% ITB , 7.5% LTGB , 7.5% ST Trsry , 7.5% Europe , 7.5% Pacific , 5.0% REIT
Compound return = 11.80%
Worst year: 2008 -23.57%

I optimized this portfolio to have the smallest drawdown in terms of worst year:

Portfolio Allocation: 27.1% LTGB , 27.1% GOLD , 20.2% EM , 12.7% ST Trsry , 7.1% ITB , 5.5% REIT , 0.3% Pacific , 0.0% COMM , 0.0% MKT-TSM , 0.0% Europe
Compound return = 11.80%
Worst year: 1994 -4.34%

Notice that it was historically optimal to have about a quarter in gold and long bonds. HB went through a back-testing process before he suggested the 4x25, if you are going to design a portfolio around different principles then back-testing might serve as a "sanity check" if you have reason to suspect that the new design should have performed well in the past.

"I halved Gold allocation and gave it to a diversified commodities ETF. Maybe I'm being emotional but 25% in gold is a bit high... will diversifying it out to commodities serve the same overall function?" Commodities won't work as well because economic production falls during the types of periods when gold is supposed to really perform. If you have a problem with putting 25% into gold then try these ideas on for size: 1) hold a smaller proportion of your total net worth in the PP but stick to 25% gold in there. 2) Diversify across precious metals, basically hold silver too. CEF is a closed-end fund that does this for you. Silver also has a very long history of monetary use. Be aware that these days Silver quacks more like an industrial metal than gold. 3) Just hold less of your portfolio in gold such as 18% - but don't think that this will be better during hyper inflation than HB's PP. 4) Keep studying about gold until you are comfortable holding 25%.

"The boring, 3-fund TSM portfolio posted above (and here, using the same stock fund at 25%) is just one type of "conventional" portfolio that has performed competitively (based on CAGR) with the PP and with slightly better drawdowns, and as good in 2008." Roy keep in mind that we have not seen sustained deflation, run-away inflation, currency collapse, foreign invasion, etc in the last 37 years. These are scenarios that the PP is designed to cope with but the other portfolios you brought up don't even have the objective of surviving these scenarios right?

"I see gold's role only in the event of severe inflation or economic collapse (like iceland), and if so, wouldn't investing in foreign stocks/bonds also serve a similar role?" The gold component has done fine as part of the PP if you look back since the 1970's, even though we haven't had the problems you mentioned. Gold has responded to the moderate inflation during that period with ease. Here is an anecdote about foreign holdings attributed to Baruch: "Gold, he insisted, is one of the very few things in the world that approaches the status of a permanent investment. Baruch told the story of a Rothschild who set up a ‘permanent trust’ consisting of five different currencies. By the time Baruch heard about the trust, it had shrunk to one-fifth its original value."

"So hypothetically let's assume the US undergoes a economic meltdown and US stocks & bonds loses 90% of their value... What's left is one quarter in gold..." The price of gold would explode in this scenario, but foreign holdings would probably be pulled down pretty significantly also because they lost a major trading partner and also lost huge chunks of dollar denominated forex reserve and investment.

Cheers!

[macclary]

[craigr]

[Wonk]

[Roy]

[6 Iron]

What a great forum from an educational standpoint. Thanks to you all.

I plan to begin the Permanent Portfolio in my 401K, using the self directed option to access a brokerage account. In addition to the 401K, I am also enrolled in a mandatory cash balance program through work. I would like to use this as the cash component of the portfolio, but I cannot draw down on it until retirement, which is many years away. I would then be left with money added to the account at regular intervals by myself/match, and the other 3 components to rebalance. I have other accounts with a financial advisor that I suspect I will eventually pull out, but I thought this would be a good way to get my feet wet, and try it on for size. Does this seem reasonable, or should I close out accounts with the financial advisor so that I can have a larger, accessible component of the cash component to maintain an overall balance?

[MediumTex]

[Roy]

[Lbill]

I have spent some time looking at the annual returns for the PP and each of the components (stocks, bonds, gold) for the period of 1972-2008. Here are a few of my observations:

Over the entire 37 year period the average annual return for the PP was 9.9% with an average annual SD of 8.4%

> Stocks returned an average of 11.0% with SD of 18.8%

> 5-year treasuries returned an average of 8.4% with SD of 6.7%. This is nearly the same as the average using equal weights of short-term and long-term treasuries.

> Gold returned an average of 11.9% with SD of 31.6%.

What is notable here is the fact that gold had an average annual return that was 8.2% greater than stocks, while the volatility of gold was 68% greater than stocks. So, it had disproportionately more risk than stocks over this period compared to the difference in annual returns. In fact, when you compare the data for the 18 years with the best average return for the PP to the data for the 18 years with the worst average return, you find the following:

_____________Stocks____Bonds_____Gold
Best Yrs. Average......17.4........10.4...........27.2
Worst Yrs. Average......6.4..........7.4.........(-4.1)
Best Yrs. SD..............17.4..........6.0...........36.7
Worst Yrs. SD............18.0..........5.4...........15.5

What is apparent is that the returns from gold contributed the most to the performance of the PP over the 18 years when the PP did the best, and it detracted the most from the performance of the PP during the 18 years the PP did the worst.

Looking at the volatilities, stock volatility was about the same over the 18 best years and the 18 worst years for the PP (17.4 vs. 18.0), while the volatility of gold was much higher over the 18 best years for the PP vs. the 18 worst years (36.7 vs. 15.5).

Why was gold much more volatile during the best PP years, but it's volatility was similar to stocks during the worst 18 years? It turns out this is due primarily to the returns for gold in 3 years: 1973, 1974, and 1979. In these three years the returns for gold were 75.6%, 70.5%, and 136.3% respectively. When these 3 years are removed, the SD of gold drops to 17.0%, and the SD of gold for the best vs. worst years for the PP about the same, and similar to the SD for stocks.

The return in 1979 alone of 136.3% is 4.3 standard deviations from the mean return for 1972-2008 - clearly an "outlier." When this year is removed from the analysis, we find that the PP average return was 9.0% with an SD of 6.6%. In comparison, 5-year treasuries had an average return of 8.5% with an SD of 6.8%, which is only an average of 0.5% less than the return from the complete PP with the same volatility.

It appears that the contribution of gold to the performance of the PP is due primarly to the single year of 1979, when it returned 136.3% (+4.3 SD). Additionally, when the years of 1973 and 1974 are removed from the analysis, the performance of the PP is not much better than the performance of 5-year treasury bonds. (8.7% average, 6.6% SD vs. 8.7% average, 6.7% SD respectively).

I don't intend this post as "gold bashing." I have been an investor in gold since 2002 and it has treated me well and I'm a believer in holding gold. But I have to admit that these data give me pause regarding a 25% commitment to gold in the PP. Over the past 37 years, if you take out only 1 - 3 years when gold had outsized gains, gold didn't do much for your total returns. You have to ask yourself whether the gains in gold - and resulting performance of the PP - in 1973, 1974, and particularly 1979 are likely to be repeated and when? I believe in some commitment to gold as "disaster insurance," but is a 25% allocation more than necessary? I'd be interested in comments.
_________________
"Whenever you find yourself on the side of the majority, it is time to pause and reflect." ~ Mark Twain
"A foole and his money is soone parted." - J. Bridges, 1587

[Clive]

-- deleted --

[macclary]

Hi Lbill, thanks for posting your musings. Here are some comments:

[Clive]

-- deleted --

[MediumTex]

For those who like to run different models, I wonder what a PP would look like with 20% zero coupon 30 year treasuries, 20% gold, 30% stock and 30% two year treasuries.

Intuitively, it seems like this might get you a little higher returns with the same or less volatility than the traditional PP.

The allocation above would be similar to owning 90% PRPFX and 10% EDV, rebalanced annually.

Note, though, that for the beginner the traditional 25% x 4 ought to be the starting point. There's no reason to get fancy when the basic HB PP works fine.
_________________
"A Permanent Portfolio should let you watch the evening news or read investment publications in total serenity."
-Harry Browne

[MCSquared]

Now consider this: if the PP returns were about the same as 5yr treasuries you would still benefit from holding the PP because of the insurance against severe shocks such as run-away inflation or depression, etc.


I have previously seen the argument that the PP gives one a treasury like return but at the expense of significant volatility. I agree with McClary's point about the insurance benefit. The odds are you do not need it....... until you do. In my neck of the woods, try buying hurricane insurance the day after a hurricane.

[Clive]

-- deleted --

[Clive]

Historically when the gold price divided by the XAU (Gold mine Index) ratio rises to 5+ signalled a good time to move out of gold price trackers into gold mines and when the ratio declined to 4- switch back again.

The recent financial crisis however saw the ratio rise to 10+ (still around 6.5 today). Interestingly however back in July 2008 the Rand (South Africa = gold mining) was at around 8 per USD. More recently the rand had strengthened to 10, but is now more recently back at 8 per dollar again. At the dollar lows/rand high's however, as priced in rand, gold had risen only about 15% whilst seeing 45% rises in dollar terms.

Us Brit's have had it much worse currency wise and as such GOLD.L (Randgold) has had exceptional performance over recent months, far exceeding gold price gains. If you think gold price gains have been strong, just check-out the randgold mines share price gains

http://uk.ichart.yahoo.com/z?s....=v&p=s

and judging by the GOLD / XAU ratio, there's still further upside potential left yet.

Here's a chart of Robert Lichello's AIM applied to GOLD.L



in the way of explanation the green and blue bars are stacked and show the cash (green) and stock (blue) amounts, so the top's of the blue bars gives a feel for the total fund value over time. The + and - are the trade points + for add, - for reduce.

From having exhausted cash reserves in July 2004, subsequent selling would have built up cash reserves nicely whilst also having seen strong gains in total fund value amounts.

Quite a good example of how a automated trading signal system can pace the stock price whilst doing so with stock+cash blend and rebalancing.

[macclary]

[MediumTex]

[Lbill]

I don't think that leaving out the single best year for gold (gain of 136%) in the last 37 years is entirely unreasonable. First, this was clearly an "outlier" because it was over 4 SDs from the mean - statistically, you wouldn't expect this to occur even once in a 37 year period. By comparison, there were no years when stocks deviated that much from their 37-year average. The best stocks did was in 1975 with a 38.5% gain (+2 SD), and the worst was -37% in 2008 (-2 SD). Of course, returns this extreme are also somewhat rare and shouldn't occur statistically more than once in 20 years, but don't qualify as outliers.
Stocks have had two such events in the last 37 years (1975 and 2008), while gold has had three (1973, 1974 and 1979). Interestingly, all three large annual deviations in the performance of gold were all on the upside (75.6%, 70.5%, and 136.3%). The worst gold did was in 1981, with a loss of -32.8% which was just -1 SD below the 37-year mean (due to the larger volatility of gold). By comparison, stocks had one large positive deviation (1975) and one large negative deviation (2008). It is instructive to view the following chart published in Wikipedia:



It is clear from the chart that there was a dramatic decrease in the dollar relative to gold that began in 1970 and was completed by 1974 (dollar value of gold increased). This was the period in which the dollar-gold peg was being removed. Two of gold's three big dollar gains occurred during this period in 1973 and 1974. There was another move that occurred from mid-1976 to mid-1979 that was smaller in absolute terms, but larger in percentage terms. This was when inflation and interest rates were accelerating. This was when gold's largest dollar gain occurred in 1979.
Data analysis is often aided by eliminating outliers, because they can be "one-time" events that have a large distorting effect. Unfortunately, it's difficult to determine if a gain this size might actually occur more often, since the price of gold was pegged to the dollar before 1972, and really wasn't fully floated until 1975.

A case could be made for also removing 1973 and 1974 from the analysis as well, since it can be argued that these gains were attributable to the one-time event of removing the dollar-gold peg.

Yes, I certainly believe the point that gold is an asset that is invaluable during certain circumstances, and I certainly do believe in holding gold (especially in the present times) to help insure against the devastating effects of these circumstances. I fear, however, that the willingness to commit 25% of one's wealth to gold might be driven by present fears, the performance of gold over recent past, and the distressing performance of stocks over the past decade. I am one who "flipped" on gold and went from skeptic to buyer in 2002, so I've profited from the rise and think there is more to come. But, unfortunately, it seems to me that the historical data since 1972 (when the dollar-gold peg began to be removed) suggests that one should probably not have this much in gold as a fixed buy-and-hold commitment. If I have to hold an investment for 37 or more years to realize it's undeniable benefits during financial and economic crises, I begin to wonder about the risk/benefit ratio of that asset. As an investor in gold and a proponent of buying gold, I arrive at this conclusion reluctantly and am quite open to being corrected and dissuaded.
_________________
"Whenever you find yourself on the side of the majority, it is time to pause and reflect." ~ Mark Twain
"A foole and his money is soone parted." - J. Bridges, 1587

[6 Iron]

[6 Iron]

Lbill,

Thanks for the information. This graph does not make the decision easier, but does go along with the the gold/rifle/flak jacket analogies mentioned earlier.

[MediumTex]

[MCSquared]

[MediumTex]

[MediumTex]

[Lbill]

MC - Not sure there's any replacement for gold in the PP. I sure don't like commodity ETFs or ETNs. For myself, I'm considering a 10% - 15% allocation to gold. Actually, if you hold all 4 assets in the PP anyway, this amounts to holding a smaller classic PP; e.g., 15% of your portfolio in gold, stocks, cash, and LTT (60% total). The other 40% is invested in "something else." So your willingness to invest the full 25% into gold (or any other of the PP assets) ends up driving your overall allocation to the PP. How would I invest that 40% - probably in a TIPS ladder or some stocks and some TIPS. Zvi Bodie has mostly convinced me that TIPS are a good idea but I wouldn't want to put 90% of my port into them, as he says he does.
_________________
"Whenever you find yourself on the side of the majority, it is time to pause and reflect." ~ Mark Twain
"A foole and his money is soone parted." - J. Bridges, 1587

[MCSquared]

[MCSquared]

[craigr]

[macclary]

[macclary]

[Clive]

An observation.

Events leading up to high gold prices tend to be progressive. As such gold gains (and declines) somewhat cluster.

If you use a timing method of - review once each year and if the current years gold gain is larger than the previous years gold gain then invest in gold for the next year, otherwise invest in cash (ST Bonds) - then historically you'd have been in gold for around 54% of time and achieved a higher overall annualised PP gain (around 1.6% p.a. more) and a lower worst year decline.

In effect employing insurance only when the need for that insurance looks more probable as depicted by the market.

If you extend this concept to invest the gold allocation in stocks instead of ST bonds when so indicated, then the CAGR rises to around 2.5% more, whilst still maintaining the low draw-downs.

12.6% average, 9.5% stdev, -2.5% min, +42.1% max, 12.2% CAGR (vs 9.8% CAGR for conventional PP). I used the first two years 1972/3 as normal PP years as there was no viable measure to test the prior two years gold gains timing for those years.

Perhaps when not invested in gold, ensuring that those funds were invested in a non-domestic currency cash/investment would provide some of the domestic currency risk protection that otherwise gold might have afforded.

And yes, based on January yearly reviews and with gold having made 30.9% gain in 2007 and 4.9% in 2008 that would have had you out of gold in the current 2009 year. Equally however from Jan to present whilst gold has risen from IAU=86 to IAU=106 at present - a 23.8% gain, similarly VTI has risen from 44.88 to 52.71 at present - a 17.5% gain.

This could be used as the The other 40% is invested in "something else." that LBill mentioned i.e. represent the Variable Portfolio.

[Roy]

Guys,

Been reading about the "unusual" high returns for Gold in the years mentioned above. While it is tempting to view astronomical numbers as "outliers," I am not convinced they are. Extreme circumstances, just like big bulls and nasty bears seem to drive emotions—and actions. Events happen.

The HB PP, as a whole, did fine during 1988-2000 (an average of 7.3% gain), during which time Gold had 12 of 13 negative years, nothing severe though. So, one might say that the PP is not "driven" by Gold, as some believe about the HB PP or PRPFX.

My question is, if Gold can achieve those extremely high returns (as in '73, 74, '79) can they not also similarly plummet? If not why not?

Roy

[Lbill]

craigr wrote:

[MediumTex]

[MediumTex]

[helmut]

I have to say that although I have gained a lot of insight by reading this thread; it sort of reminds me of the engineers I work with. When I ask them what time it is they tell me how to build a watch.

I guess this is my clumsy way of saying while I understand the general direction of what is being discussed, I’m not sure I have a complete grasp of all the different aspects of the PP strategy so I better keep reading.

I have just about decided to put half of my portfolio into a PP, but I have several issues I have to overcome. Because a large majority of our portfolio is located in our retirement accounts I will have to use funds at T. Rowe Price and Vanguard to complete my PP portfolio. I will have to use PRULX, VUSTX & VFISX. I understand that these funds are not ideal, but at the present time I don’t have much choice.

How much will these funds skew the PP portion of my portfolio?
helmut
_________________
"Back of every mistaken venture and defeat is the laughter of wisdom, if you listen." -Carl Sandburg

[macclary]

[Lbill]

Here is another chart of the dollar value of gold. The chart I posted previously from Wikipedia stops at 2003. This chart stops at March 2008. You can better see the 5-fold increase in the gold price that began in 1977 and culminated in a 136% blow-off in 1979. This chart also shows the dramatic increase in the gold price since 2002, which exceeds the 1977-79 rise in percentage (logarithmic) terms. Is gold in a bubble? Nobody knows, but I think it is wise to follow Buffett's advice about investing: if you can't stand to lose 50% of the value of an investment in stocks, then you probably shouldn't be putting any money into stocks - or at least only the amount that wouldn't compel you to sell everything. I think the same argument applies to gold, as it is at least as volatile as stocks. Although gold and stocks have historically had a low, or negative, correlation it is certainly possible for them to both incur large losses simultaneously. For example, some (such as Roubini) are now arguing that the 0% interest policy being pursued by the Fed has created the "mother of all carry trades" for the USD, which is driving up the price of stocks, commodities, gold, and every other risky asset class. When that carry-trade unwinds, the only thing that will go up will be the value of the USD against other currencies. All other assets: stocks, bonds, commodities, and gold will be viciously sold off and incur large losses. This scenario worries me a great deal, as 75% of your PP could go down the toilet, which has never happened to my knowledge.

_________________
"Whenever you find yourself on the side of the majority, it is time to pause and reflect." ~ Mark Twain
"A foole and his money is soone parted." - J. Bridges, 1587

[Roy]

[MediumTex]

[MediumTex]

[MediumTex]

This is really an awesome thread.

I know it is quite long, but I think that it is great to have one repository on the internet of so much thinking and commentary on the PP strategy.

For anyone who is wondering if there is anything like this anywhere else on the internet, to my knowledge this is by far the most detailed and informed discussion of the PP anywhere.

If a person were to print out this thread (which would run hundreds of printed pages) and purchase "Fail Safe Investing" ($9.75 for e-book version on HB's website) and pick up a used copy of "Why the Best Laid Investment Plans Usually Go Wrong" (used copies are on Amazon for under $10), you would have a powerful collection of information and data about the PP strategy.
_________________
"A Permanent Portfolio should let you watch the evening news or read investment publications in total serenity."
-Harry Browne