There are several ways to go about building wealth, and success seems to come down to one key factor: risk versus reward.
Many investors aren’t willing to accept even moderate risk, which can limit their returns. Others take on excessive risk in the search of Wall Street riches. But the vast majority of investors take a middle-of-the-road approach, investing in stocks and other high-growth assets as well as bonds and other safe-haven assets.
One investment portfolio that has become popular due to its exposure to four classic key assets is known as the Permanent Portfolio, an investment model developed by the late Harry Browne.
What Is Harry Browne’s Permanent Portfolio?
Browne was an influential American writer, politician, and investment advisor. He authored several books and numerous articles about investing and libertarian politics, and was elected as the Libertarian Party’s presidential nominee in both 1996 and 2000.
The portfolio Browne developed was based on a long-term investment strategy designed to protect the investor from volatility through heavy diversification across four key assets: U.S. stocks, long-term bonds, cash, and gold.
The investment portfolio balances these assets to provide something resembling fail-safe investing to the risk-averse investor who’s a fan of low volatility but still wants exposure to equities.
The portfolio was designed to remain resilient regardless of economic times and require little by way of adjustments, even if your investment goals change. In fact, the portfolio was designed to be so resilient that Browne once said, “Once you set it up, you never need to arrange the investment mix — even if your outlook for the future changes.”
This means the portfolio classifies as a so-called “lazy portfolio,” which requires little work by the investor.
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Portfolio Asset Allocation
The Permanent Portfolio is one of the easiest to set up in terms of asset allocation — there are only four assets in the mix, all part of different asset classes and all equally weighted. Here’s how it works:
- U.S. Stocks. The first asset to include is U.S. stocks. Traditionally, this is done with an exchange-traded fund (ETF) covering the broad United States market, but it can be tailored to fit your needs if you’re looking for growth, income, or value investing opportunities, or if you simply want exposure to specific sectors.
- Long-Term U.S. Treasury Bonds. Next up is long-term U.S. Treasury bonds. These investments come with the highest yields of any Treasury debt security because they come with maturities of 10 years or longer.
- Cash. While many investment advisors would recommend against holding a large chunk of cash because it leaves your portfolio susceptible to inflation, Browne suggested holding cash in your portfolio as a way to protect yourself in times of recession.
- Gold. Finally, Browne was always a proponent of the stability offered by gold and suggested that it make up a large portion of just about any investment portfolio. It’s not shocking that he would include it as 25% of his allocation.
The Investment Thesis Behind the Portfolio
The investment thesis behind the portfolio is simple. Much like the Ray Dalio All Weather Portfolio, the Permanent Portfolio was designed to provide positive movement regardless of the shape of the economy, with assets chosen to address specific economic cycles.
The idea is that by evenly distributing investment funds across assets that do well in each economic cycle, your portfolio will be protected against any significant drawdowns, regardless of economic conditions. Here’s how it works:
The first quarter of assets in the portfolio is allocated to stocks that represent U.S. companies. This is the perfect asset for economic expansions when interest rates are low and prices are headed up.
During these times, consumers are more likely to spend money, equating to increased corporate revenues and earnings, and ultimately price appreciation in the stock market.
Long-term bonds are a great source of protection against deflation. In particular, the portfolio invests in government bonds, which offer the ultimate protection in terms of strength and stability.
However, these bonds also have a drawback. Because they are such stable, reliable investments, the potential return on these assets is relatively low compared to other investment opportunities.
Nonetheless, should a recessionary cycle and deflation set in and stock prices fall, bond prices tend to rise, helping to balance out the declines and keep your portfolio on the right track.
The next asset on the list for this diversification-centric portfolio is cash. Most investors tend to stay away from holding cash because inflation eats away at its value. However, in times of economic recession, when prices are falling, the value of cash increases.
This is yet another safe-haven asset that’s placed in the portfolio to protect its overall value when the stock market takes a dive.
Finally, gold is an interesting asset thanks to its versatility. In this portfolio, it’s used as an inflation hedge. When the economy experiences a period of inflation, the value of gold generally rises. This helps to offset the losses cash experiences during these times.
Gold actually serves double duty in this portfolio. While it does protect your portfolio against cash-value losses from inflation, it also serves as a safe-haven investment when markets are declining. During these times, investors tend to abandon stocks and look for safe-haven opportunities, with gold being one of the most popular. As a result, when markets experience pullbacks, gold prices tends to rise in an inverse relationship.
Pro Tip: You don’t have to build this portfolio in your brokerage account yourself. If you use M1 Finance, you can simply load the Permanent Portfolio Portfolio prebuilt expert pie to gain access to a curated allocation of securities that follows this strategy.
Pros and Cons of the Permanent Portfolio
There are several advantages to investing using the Permanent Portfolio style. On the other hand, there are some drawbacks you should consider before getting started as well.
Permanent Portfolio Pros
The Permanent Portfolio has become incredibly popular, and such popularity isn’t earned in the stock market without results. Some of the most exciting elements of this portfolio model include:
- Safety. The portfolio was built with safety in mind. Designed to ebb and flow with the market, regardless of market conditions and economic cycles, those who use this portfolio strategy don’t have to worry about significant losses even in times of economic hardship, which is particularly attractive for investors nearing retirement.
- Reasonable Returns. Historically, the portfolio has a compound annual growth rate of just over 7%. While it falls below the long-term average return rate of the S&P 500 index, it is one of the more aggressive among a list of safe portfolios, making it an attractive choice for investors looking to generate as much growth as possible while accepting minimal risk.
- Easily Managed. The portfolio consists of only four assets, making it incredibly easy to set up and manage. Moreover, as a buy-and-hold portfolio, rebalancing can be done less often, allowing you to focus your time on what’s important to you.
- Low Cost. There’s always going to be cost involved in investing, however, this particular strategy comes with much lower costs than other portfolios. The reduced costs are the result of the assets of focus. Index ETFs focused on U.S. markets and long-term bonds tend to have the lowest expense ratios when compared to their peers. Moreover, gold is inexpensive to maintain, and cash costs absolutely nothing to hold onto.
Permanent Portfolio Cons
While there are plenty of reasons to be excited about deploying this portfolio strategy, there are also some issues to consider before diving in. The most important of these include:
- Cash. Historically, cash is a terrible investment. While it is a source of protection in times of recession, most financial advisors would suggest keeping cash holdings low because inflation-related losses over time will likely outweigh any positive movement experienced during recessions.
- Heavy Gold Allocation. Yes, gold has historically been a great hedge against inflation, and it acts as a safe haven. However, precious metals have a long history of underperformance compared to other relatively safe options. While gold does have a place in any well-balanced portfolio, few experts would suggest holding 25% of your portfolio’s value in gold.
- You Won’t Beat the Market. The total return on the portfolio is decent at around 7% annually on average. However, that annual return is quite a bit lower than the 10% investors look for in broader markets. Although the Permanent Portfolio’s returns are respectable for the most risk-averse investors, it’s not a good fit for everybody.
Who Should Use the Permanent Portfolio?
The permanent portfolio isn’t a great fit for all investors, which says nothing against the strategy. After all, there are few portfolios that offer a one-size-fits-all approach to investing.
So, what types of investors stand to benefit the most from taking the Permanent Portfolio approach?
- Retirees and Those Nearing Retirement. The portfolio is known for producing slow and steady upward movement with minimal losses in tough economic times. As a result, retirees and those nearing retirement — investors who simply can’t afford to take a big loss because they don’t have the time to recover — will benefit greatly from the portfolio.
- The Risk-Averse Investor. Some people aren’t anywhere near retirement, but are fearful of the risk that heavy allocation to stocks comes with. These investors are willing to give up some potential returns to avoid significant losses during economic declines, which the Permanent Portfolio offers.
- The Young Investor Just Learning the Ropes. Before taking a more aggressive approach to investing, investors should take the time to learn about the market. While educating yourself, it’s a good idea to follow a safe investing strategy to get your feet wet and gain some exposure to the potential profits the market has to provide. If you’re still learning about the market but don’t want to delay your entrance any longer, this is a great portfolio to get you started.
How to Duplicate the Permanent Portfolio
The traditional Permanent Portfolio is simple to set up because it only includes investments in four assets. However, it’s important to consider alternate renditions of the portfolio that have the potential to increase your earnings potential. The most common renditions include:
The Traditional Permanent Portfolio
The traditional Permanent Portfolio setup includes investments in U.S. stocks, Treasury bonds, cash, and gold. Here are four funds that reflect the asset allocation of the core portfolio:
- 25% in Vanguard Total Stock Market Index Fund ETF (VTI). The VTI fund is a diversified portfolio of investments in U.S. stocks spread across all sectors and market caps, giving you widespread exposure to domestic stocks.
- 25% in Vanguard Long-Term Treasury Index Fund ETF (VGLT). The VGLT fund is a Treasury bond ETF that invests in long-term Treasury securities, which are bonds with maturity dates of anywhere from 10 to 30 years.
- 25% in Vanguard Short-Term Treasury Index Fund ETF (VGSH). The VGSH fund is a cash-equivalent asset in the portfolio. The fund invests in short-term Treasury debt securities, including bonds and other assets, with maturity dates of under three years. Alternatively, you could choose to hold uninvested cash instead.
- 25% in Aberdeen Standard Physical Gold Shares ETF (SGOL). There are many ways to invest in gold. The SGOL fund is an excellent gold ETF option. The goal of the fund is to track the returns of gold bullion, or physical gold, offering the inflation hedge the portfolio strategy calls for.
The International Permanent Portfolio
While U.S. stocks offer the most stability in equity investments, international stocks often offer a larger opportunity for growth. For investors who would like to take a more international approach, there’s only one swap you need to make.
Instead of your stock investments being placed in the VTI fund, which focuses on domestic stocks only, you can allocate 25% of your investment funds in an international stock index fund. One of the best on the market is the Vanguard Total World Stock Index Fund ETF (VT).
The VT fund invests in U.S. stocks as well as stocks around the world in both developed and emerging markets. With diversification at its core, the fund invests in a wide range of sectors and market caps.
The Leveraged Permanent Portfolio
Due to the portfolio’s lower-than-average returns, some investors have added leverage to their holdings in an attempt to expand earnings potential. Keep in mind, any time earnings potential is expanded, so too is risk.
Leveraged portfolios are designed to amplify the results of the underlying assets. For example, a 3X leveraged S&P index fund would seek to triple the results of the S&P 500 index, whether those results are good or bad. These funds also come with higher expense ratios, as management fees and trading costs are increased.
If you’d like to add leverage to the Permanent Portfolio, it takes a bit of averaging and moving things around.
First, instead of investing 25% in long-term Treasury debt securities and 25% in short-term Treasury debt securities, you can average that out by investing 50% in intermediate-term Treasury debt securities in a leveraged fund. From there, both gold and stocks would be leveraged as well. Here’s what that looks like:
- 25% in ProShares UltraPro S&P 500 Fund (UPRO). Using leverage, the fund aims to produce three times the returns of the S&P 500. The expense ratio on the fund is 0.93%, which is reasonable among leveraged funds.
- 35% in ProShares Ultra Gold Fund (UGL). Although there are no 3X leveraged gold funds on the market, UGL is a 2X leveraged fund, seeking to double the gains or losses generated in the gold market. The expense ratio on the fund is 0.95%.
- 50% in Direxion Daily 7-10 Year Treasury Bull 3X Shares ETF (TYD). The TYD fund uses leverage to produce three times the returns generated through intermediate-term Treasury debt securities. The fund comes with an expense ratio of 1.25%.
Keep Your Portfolio Balanced
As with most investment portfolio strategies, when investing using the Permanent Portfolio strategy, it’s important to keep your portfolio balanced. The thesis behind the investment is that by balancing your funds across key asset types, you’ll enjoy steady growth while protecting yourself from economy-related headwinds. That means regular rebalancing is a must.
As a buy-and-hold portfolio, you won’t have to rebalance on a monthly basis. In fact, some suggest that these portfolios are designed to be rebalanced once annually. However, this portfolio was designed for the safe investor who might not feel comfortable going a year without adjusting holdings.
All told, this portfolio does well when balanced once quarterly. To do so, simply divide your total portfolio value by four and move money around to ensure each asset in the portfolio represents one-quarter of your holdings.
All in all, the Permanent Portfolio is an excellent option for those looking to decrease volatility risk while they learn about the market or as they enter retirement. The portfolio offers reasonable gains, albeit lower than the overall market, while keeping your funds safe and steady.
Investors who want to mix things up a bit to expand their return potential can apply leverage, but it’s strongly suggested that you do your research and understand the risks before doing so.