Bogleheads

[Lbill]

I have a portion of my portfolio in 4 x 25 PP and have invested in gold since 2002, and I plan to keep holding the PP and gold, don't get me wrong. However, I think anybody who does this should have a clear head about why they are doing it and what they might experience. In particular, right now gold is the "investment du jour" but that is a stupid reason to hold it, just as it is stupid to hold stocks for the same reason.

Simplistically, the PP seems to me to be a "hope for the best, but prepare for the worst" rainy-day kind of portfolio. With only 25% allocated to the "prosperity" investment - stocks - this is sure not an optimist's portfolio. And that's why I like it - I consider myself to be a "skeptical realist." If you are going to invest this way, I think you need to be prepared for really long periods of time when it will underperform and even not do much better than T-bills or being 100% in safe intermediate bonds. Bill Bernstein pointed out those who choose to own gold-related investments should be prepared for the very long term of 20 years or more that gold can be a real dog. That's what happened from 1980-2002 and it dragged down the PP. From 1981-2000, the average annual return of gold was (-3.2)%. Now, maybe that won't happen again and there are lots of logical reasons to own the stuff now, but it is not consistent with PP philosophy to own gold because we think we know the future - we don't. It is held as insurance against monetary catastrophe. If we happen to make some money holding it that's a nice bonus, but we could just as likely end up losing money as well. Of course, the same applies to stocks and long-term bonds. The Japanese stock market has been a dog for nearly 20 years now, and the US market is well on the way toward matching that.
_________________
"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

[MediumTex]

I think that one of the important things to understand about the PP is the types of scenarios under which each of the four asset classes would do well.

I have focused on gold because that seems to be the one that is least understood as part of a diversified portfolio of non-correlated assets.

The idea with the PP is to be able to read the newspaper without stress.

Those who plan only for good times will be disappointed some of the time, as will those who only plan for bad times. The PP simply plans for an unpredictable future in which humanity will invariably showcase both its brilliance and its stupidity (the amount of each varies with the times).

One of the most common causes of investor hand-wringing that I see is when the government does something and people say to themselves "oh no, the government is doing something stupid, that really worries me."

No prudent investor should EVER be surprised by the government doing something stupid. In fact, long periods of utter incompetence among politicans and central bankers should be incorporated at the granular level into any long term investment plan.

Think about how many people have basically lost half of their life savings because they believed the Wall Street and Fed claptrap about the health of the economy, the value of long term investing, and the amazing globalized world economy.

Think about the following comment by Voltaire: "The rich require an abundant supply of the poor." Understanding the implications of this statement makes it clear how many of the ideas people hold about investing CAN'T be true, since if they were it would only be a matter of time and compound interest until every single person in the U.S. was rich and living off of their dividend checks.
_________________
"A Permanent Portfolio should let you watch the evening news or read investment publications in total serenity."
-Harry Browne

[Lbill]

Following my comments in a previous post, I was curious about how many years the PP underperformed T-bills in the 20-year period following the peak of the gold price in 1980. Using Craigr's data on his website here's what I found:

Underperforming Years

1981
1983
1984
1988
1990
1992
1994
2000

So the PP underperformed Cash in 8/20 years or 40% of the time. It performed nearly the same as all Cash in 1987 and 1996. So altogether about half the time in the 20 years 1981-2000, the PP performed worse or not much better than 100% Cash. In addition, it also underperformed cash in 2001 and 2002 (when the current bull market in gold began). It also underperformed in 2008.

I hold the PP and I'm not trying to argue against the PP, but just to provide some perspective on it for those pie-eyed investors who suddenly think it's a good idea because they've been beaten up in the stock market. When the stock market regains it's health, those investors will drop the PP like a hot rock. Before you do it, ask yourself if you're realistically willing to hold a portfolio that could well be beaten by holding only T-Bills for a good portion of the time for the presumed benefit of having some inflation and deflation disaster insurance in place? I am, but maybe you aren't.
_________________
"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

[MediumTex]

The PP is much better at keeping you from becoming poor than it is in making you rich.

I think it's important to note, too, that what the PP has provided since the 1970s is a nice inflation-adjusted return of about 4% per year. No other allocation of which I am aware can claim to have stayed that far ahead of inflation over that period of time.

We have had an exceptionally long period of low inflation since teh 1980s, but it is in the NATURE of fiat currency to have periodic bouts of high inflation, so we are virtually certain to see such episodes in the future at some point. During those periods, the PP is likely to do better than t-bills on an inflation adjusted basis.

To a degree, I think that the PP is only suitable for people who have a certain kind of predisposition and worldview. There will always be those who think the PP is crazy, and some of those people will laugh all the way to the bank (assuming the bank is still open).

As Thoreau said: "I trust that none will stretch the seams in putting on the coat, for it may do good service to him whom it fits."
_________________
"A Permanent Portfolio should let you watch the evening news or read investment publications in total serenity."
-Harry Browne

[matt]

Lbill wrote:

[Roy]

[Wonk]

[matt]

Wonk,
Yes, most investors choose their asset allocation based on past relationships.

Most investors are not good at investing.

[MediumTex]

I like the way HB described past performance.

He said that past performance is really only a good way of telling if something DOESN'T work, but is not helpful in telling whether something that has worked well in the past will continue to work in the future. This is where it is critical that you understand WHY what you are doing is working (or why it should be working, anyway) or why you believe it will continue to work, rather than looking at a nice chart and investing based upon that alone.

When HB came up with his PP hypothesis, he back-tested it and discovered that history did not disprove his hypothesis. However, the fact that history did not disprove the hypothesis only caused him to believe that the same things that made the PP work well historically SHOULD cause it to continue working well in the future.

He took pains to point out, though, that faith in the value of the PP approach should not be based upon its past performance, but rather because it is a dynamic and well designed approach to investing that happens to have a good record.

If an investor isn't able to make the distinction between past performance as a way of invalidating a hypothesis (which is where it is useful) and past performance as a way of determining what future returns are likely to be (which is where it can be very misleading), then it will always be tempting to chase returns.

The point I am making is a subtle one, but it has been very useful to me. It allows me to look at any investment strategy and see the past performance as merely a quick way of seeing whether history disproves the strategy, not whether the strategy is likely to continue working. In order for me to decide whether I believe the strategy will continue working, I must do a lot more homework.

For example, I like the energy sector very much for my variable portfolio. I like it partly because its strong historical returns do not disprove my thesis, and I like it partly because I believe that there are currently fundamental factors in place that will allow the energy sector to do well going forward as well.
_________________
"A Permanent Portfolio should let you watch the evening news or read investment publications in total serenity."
-Harry Browne

[newbie001]

Wonk, you posted something similar to what I was thinking, namely that the PP seems to be a portfolio designed on the basis of the historical correlation (or lack thereof) between its 4 asset classes.

[MediumTex]

[Lbill]

[MediumTex]

HB talked about how the PP was responsive to the following four economic conditions:

Inflation
Deflation
Prosperity
Tight Money

HB's thinking was so brilliant and subtle (to me), I think you could also say that the PP is responsive to the following four social and cultural conditions:

Pessimism
Optimism
Fear
Apathy

I would say that one of those moods seems to be predominant at any given time and that there is an asset class in the PP that does well during each of them.

I am so impressed with the fact that the PP can actually be treated as a PERMANENT portfolio. It's the kind of thing I can talk to my kids about and be confident that if they use it in their investing careers they are unlikely to regret having taken my advice. They're 7, 5 and 1 right now, though, so we've got some time on that one.

Overall, I just want to minimize the role of luck in my investing career. I don't want to bet my life savings on being in the right place at the right time. In other words, I want to stay out of Nassim Taleb's "Extremistan" as much as I can. The PP is one way of doing that.
_________________
"A Permanent Portfolio should let you watch the evening news or read investment publications in total serenity."
-Harry Browne

[MediumTex]

[Lbill]

Tex - that's a good idea to look at real returns by adjusting for the CPI. I'll see if I can figure out how to do that. FWIW, I used my spreadsheet to fiddle around with the weightings of the 4 assets to see if I could get closer to having approximately the same correlation between each asset and the total performance of PP since 1972. I reasoned that this might make some sense because during that time we've been through a high inflation and interest rate period, at least two significant bear markets for stocks and a huge bull market for stocks, two very good periods for gold and a protracted lousy period - in other words a lot of stuff has been going on during the last 37 years! If there is any sense to having an "unbiased" PP (using correlations of each asset with total PP as the measure of "bias"), then here are the weights I came up with and the corresponding correlation of each asset with total PP using those revised portfolio weights, rebalanced annually.

Asset--------Portfolio Weighting--------Correlation with PP

TSM.............. 22.5%..............................50.2%
ST BOND ...... 30%................................42.6%
LT BOND ........30%................................47.9%
GOLD.............17.5%..............................50.9%

I found that the CAGR of this "revised" PP for 1972-2008 was 9.4% with an average annual SD of 7.1% - quite comparable to the 25 X 4 portfolio.

Now there are probably other weighting schemes that would work, but I'm imagining that all of them would have to decrease the weight for both stocks and gold (since they are the most volatile assets) and increase the weight for ST and LT Bonds. Of course, any changes from the equal 25% weighting scheme of the original PP based on the last 37 years of data would be assuming that the future would be similar to this period of history - always a problem with any schemes based on backtesting. However, these results might provide a rationale to those who are uncomfortable with the 25% allocation to gold (and stocks for that matter) to justify reducing those weights somewhat in favor of bonds.
_________________
"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]

[Wonk]

[Wonk]

[MediumTex]

[MediumTex]

[dumbmoney]

Tex mentioned Taleb... Browne and Taleb definitely seem to be on the same philosophical wavelength, even though their investment approach is completely different.

Both emphasize the unreliability of inductive economic reasoning (e.g. B has followed A in the past, therefore B will follow A in the future).

Browne is obsessed with safety moreso than any other financial advisor I know of. He didn't consider it unreasonable or paranoid to plan even for "the unthinkable" - events that seem unlikely and have never happened before. For example, he recommends splitting your stock allocation between 2 or 3 funds, just in case, and avoiding funds for bonds and gold. And keeping some assets outside your own country.

At the same time, he warns against building your life around a particular disaster scenario, because we don't know what disaster (if any) will come. And life is short, so don't forget to enjoy the present.
_________________
I am pleased to report that the invisible forces of destruction have been unmasked, marking a turning point chapter when the fraudulent and speculative winds are cast into the inferno of extinction.

[Roy]

[MediumTex]

[Lbill]

[Verde]

[Lbill]

Bravo Verde! Interesting results. I note that PP was similar to US in that the SD is lower than everything except T-bills so it tends to smooth out the ride.
_________________
"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

[Verde]

25 year returns Japanese market in US$ vs US market.

[MediumTex]

So it looks like a Japanese PP would have provided similar safety to a U.S. PP.

I would think that the PP would work well in most modern economies.
_________________
"A Permanent Portfolio should let you watch the evening news or read investment publications in total serenity."
-Harry Browne

[ziggy29]

[HBfan]

I am looking at setting up a college savings plan for my child. I would like to do the PP for him. From what I can tell, all 529 plans only allow a limited selection of investment options. This doesn't make it easy. I think it would be possible with a coverdell, but there are advantages to the 529 (higher contribution limit and it has been made permanent).

Any advice?

[Lbill]

MediumTex said:

[MediumTex]

Lbill, that's a great point about the 60/40 allocation, but the 60/40 allocation seems likely to suffer during a period of deflation, which we may be in right now (especially since stocks and corporate bonds are not really non-correlated in a deflationary environment). The 1972-2007 period didn't provide any deflationary exposure to speak of, but I think that one of the beauties of the PP is that it still provides a good inflation-adjusted return in a deflationary environment as it does in an inflationary environment, where most other portfolios get killed in a deflationary situation.

If deflation is running at 2%, a 4% return looks pretty good.

As I recall, the Coffehouse approach lost 20% in 2008, much worse than any year of the PP since 1972.

(link: http://madmoneymachine.com/portfolios/)

But the PP is certainly not the only game in town when it comes to safety.
_________________
"A Permanent Portfolio should let you watch the evening news or read investment publications in total serenity."
-Harry Browne

[Verde]

Japan market Dec 1971 – Dec 2008. PP performance through bulls, bears, inflation, deflation.
Based on monthly data. Rebalancing bands +/- 10%. PP was rebalanced 14 times over the 37 years.

[Lbill]

[Wonk]

Verde, thanks for the Japan data. It's unfortunate the LT bond data does not exist for comparison puposes. I suspect the numbers would be even better for the Japanese PP if that data was included.

I don't think the 10 year bonds have enough deflation-busting power as their 30-yr counterparts.

[MarcDeMesel]

The Cash Part

I don't understand why Harry Browne allowed cash to be lend out even in treasury bills.

Cash is the only asset in the permanent portfolio that will protect you against a strong deflationary environment where not only stocks and gold crash in value but the government also defaults on their obligations.

In such a strong deflationary environment you not only lose the money lend out in Long Term Government Bonds, but you also lose the cash lend out in very short term Treasury Bills.

I agree with Harry Browne that chances are small that the government would default in a fiat currency system where they can print as many dollars as they want in order to furfill their obligations. But still, one cannot forsee what politicians might decide. It is always possible that some official changes their mind and decides to stop inflating the dollar and instead choses for default. Also, there are other possible scenario's, that we might not even know about, that could lead to the default of the government in a fiat currency system.

True, in an environment where strong western governments would default, even though gold will go down nominale in value, in buying power it will likely go up as it is the last safe heaven remaining. However, it is uncertain that it would compensate for buying power being lost in the 3 other assets of which 2 of them, treasury bills and long term treasury bonds, would go to zero.

Therefore, why is the cash being lend out? Isn't this in contradiction with the philosophy of the permanent portfolio to be protected against all 4 possible scenario's, deflation included?

[MediumTex]

[dumbmoney]

A deflationary depression can't trigger a U.S. default, since the government can (and certainly would) print money.
_________________
I am pleased to report that the invisible forces of destruction have been unmasked, marking a turning point chapter when the fraudulent and speculative winds are cast into the inferno of extinction.

[manuvns]

With prices of gold at all time high . Gold might be the next bubble . It's too late to buy gold now .

http://economictimes.indiatime....304788.cms

[Wonk]

[MediumTex]

I would like to hear others' thoughts on rebalancing bands.

HB recommended 15% and 35% in his 25% x 4 allocation.

PRPFX uses 10% above or below each asset's target allocation (I think), which is a much narrower rebalancing band than HB's PP.

For example, if I am understanding correctly, PRPFX would rebalance as follows:

gold - 20% - rebalance at 18% or 22%
silver - 5% - rebalance at 4.5% or 5.5%
Swiss franc - 10% - rebalance at 9% or 11%
Stocks - 30% - rebalance at 27% or 33%
Treasuries - 35% - rebalance at 31.5% or 38.5% (I don't know how they rebalance along the yield curve)

What strikes me as odd is that HB's PP and PRPFX have similar long term performance. It would seem that one rebalancing strategy would be better than the other, but both approaches seem to yield similar performance.

Any thoughts on when it's the right time to rebalance?

I like 20% and 30% in the 25% x 4 allocation.
_________________
"A Permanent Portfolio should let you watch the evening news or read investment publications in total serenity."
-Harry Browne

[Wonk]

Medium Tex,

I posted a similar question recently with regard to rebalancing (% or bands).

I had seen an interesting post discussing rebalancing once every 3 years for maximum return. Just found it here:

http://www.bogleheads.org/foru....nce++years

When looking at some of the data presented, the gain is smaller than I remembered: about 10 bp at 3-4 yrs rebalance.

I would think the 15 & 35% bands would be just fine (if triggered) with new funds adding to the annual laggards.

[snowman9000]

Right now I'm paralyzed with fear, so I'm not doing any rebalancing. My lowest quad is 18% and the two highest are ~30%. So it's fine I guess. But personally, I think 20-30% is a better band than 15-35%. On paper anyway. In reality, who knows. Tracking error can help you or hurt you, either way. 15-35 seems awfully wide.

[Snoopy]

IMO, since each of the 4 asset classes are so highly noncorrelated, each one needs to be fairly close to 25% at all times in order to carry the weight of the entire portfolio, if called upon to do so.

Because of this, I prefer to use the tighter 20-30% bands with my PP.

[Wonk]

Manuvns,

If you're still reading this thread, I think the following brief article makes a compelling case for why gold still has room to run:

http://www.fxstreet.com/fundam....02-23.html

I've read several write-ups on this phenomenon and it's fascinating. Who knows, maybe we'll see Dow/Gold at 1,000 each...in which case, you can assume Gold has peaked.

But the more likely scenario is a 1:1 or 2:1 ratio when gold peaks relative to the Dow. I'll be backing up the truck with my VP to buy equities when we see a 2:1 or better ratio. Whether that's at 5,000, 10,000 or 1,000 I don't know...

Currently, we've been fluctuating around 7:1 & 8:1.

[MediumTex]

RE the rebalancing issue, it seems to me that assuming transaction costs are not a factor, it is unlikely that anyone ever went broke rebalancing a well-designed portfolio.

I think that is David Swensen's thinking in the way he rebalances often.

RE gold, there is clearly plenty of room for it to run if that's what the market decides. The current chart looks pretty bullish to me.

If, however, stocks continue to rally, gold may dip down into the $700s.

Who knows?
_________________
"A Permanent Portfolio should let you watch the evening news or read investment publications in total serenity."
-Harry Browne

[diasurfer]

MediumTex, I hold nothing near a permanent portfolio and don't plan to in the foreseeable future, but I've enjoyed reading your posts and have learned a fair bit.

The only thing I'd point out is that you've repeatedly emphasized that HB spent 30 years perfecting his PP, and you advise going against his recommendations. So why would you decide that you can tinker with the rebalancing bands he determined?

[stratton]

[MediumTex]

[snowman9000]