cosmic wrote:Finally, "being afraid" is not a reason not to invest. One should make financial decisions based on what will have the best reward/risk ratio whose maximum expected loss does not exceed your risk tolerance. Not based on what causes you to experience less fear or other negative emotions. If doing the right thing is scary, it is no less right. The solution is not to to the wrong thing, but to overcome or ignore your fear. You would be better off investing all-in today, then spending 1% of your total portfolio value on therapy sessions with a professional psychologist, because it will pay for itself within 2-3 months.
It's important to do rational analysis. "I'm scared" is a valid reason to run away from an alligator or a gunfight. It is not a valid reason to reduce your expected portfolio returns.
I like your thinking and comments. Very smart and funny.
However, separating emotion and rationality is not as easy for many people as you suggest. When the market is plunging, it is not irrational to feel fear--it is a response that is hardwired into us from millions of years of trial and error in running from alligators and other things with large teeth.
My goal isn't to make sure investors have achieved a state of samurai-like mental discipline before they start investing. I would like to see a person who is interested in the PP buy into it completely on day one, but if they need a little time to ease into the concept I understand the idea of getting comfortable with a strategy incrementally (even if it is at the expense of some lost returns). If the PP really is a "permanent" allocation method (which I think it is), I don't see much harm in scaling into it over a few months or even years if that's what helps a particular investor create a durable commitment to the strategy.
The next time I am talking about the PP with someone, though, I hope I have a chance to tell them that rather than letting their irrationality interfere with their investment returns they should consider setting aside a portion of their assets to pay for a therapist to help them become more rational.
Ok, I understand - and I agree that ultimately if something isn't "do-able" for someone, no amount of theory will help. I'd perhaps suggest a compromise - go all in with one portion, maybe 30-50%, then average in with the rest?
Let me know what response you get to the therapist option, I hope it's not violent!
Anyway, here's some more ideas about the PP and its merits. Some people have wondered what are the source of its returns. Historical performance shows it performs solidly, and it was designed 30 years ago so this is (unlike many portfolios) not the result of data-mining and hindsight bias. But how do we know it's not just luck, or a historical anomaly?
One good way to see if results are luck, or if they are robust and can be expected to last, is to look at economic theory. Here the PP is solid - the expected return from gold should be roughly in line with inflation, since it's a money substitute; cash should be roughly in line with inflation, since it's just money; long bonds have more risk so should return a bit more than inflation, maybe 1-2% more, and stocks have higher risk so should return quite a bit more, maybe 4% more than inflation (especially if it's small caps or emerging markets). This is all in line with economic and investment theory. Therefore the PP, with 1/4 in each, should return at least inflation plus the average real returns of its combined assets. I.e. 0.25-0.5% from long bonds, 1% from stocks, and 0 from cash and gold. That gives a 1.25-1.5% return. Rebalancing also improves returns. Clive (who posted on this thread) looked at historical returns and Monte Carlo analysis and got a figure of 1.5% real return from rebalancing. So the total expected theoretical return of the PP should be about 3% above inflation in the very long-run. This actually fits fairly well to the historical returns. The USA and west benefited from falling interest rates from 1980 - but Japan also shows a 4% real return from the data. So the history fits very closely to what theory predicts. That is a solid result and significantly increases my confidence in the soundness of the Permanent Portfolio.
In another post on this thread, clive suggested Mebane Faber's 200 day moving average diversified portfolio. Split capital 20% each in stocks, foreign stocks, REITs, bonds, and commodities, and sell each portion if the price falls below the 200 day moving average. Buy back when it closes above the 200 day MA. To avoid whipsaws it uses only monthly data for signals. Historically this has returned above 10% with moderate drawdowns.
Based on the record, it's an excellent system. There is one problem - there is no economic/theoretical reason why using a moving average should reduce risk or increase returns. In trending markets it will boost returns, in choppy markets it will reduce them. So no matter how good the data, one lacks the confidence from theoretical support for the results. And I read that the outperformance of the system is not statistically significant to a very high confidence level. Buy and hold using Monte Carlo analysis produces better results a certain % of the time. So it could be these results are blind luck. If Faber's portfolio underperforms for 10 years, how will you know if it's just an aberration, or if the previous 30 years results were the aberration and actually the method doesn't work at all?
For that reason, I think the PP can be relied on with more confidence. Even if it does perform badly for a while, it means that the bonds, stocks and/or gold have become a lot cheaper, and the cash is rebalancing into them, buying low, so if you are down 20% then it's too late to sell and you are getting relative bargains - just sit tight is the best response. With Faber's portfolio you could be down 20% and about to get whipsawed to death for the next 20 years in choppy markets, and you are selling low and buying high instead of the other way round.