The Permanent Portfolio: A Fail-Safe Investing Method?

03 December 2012 · 11 comments

Investing is complicated. It’s difficult. You need expert help if you’re going to build your wealth so that you can retire on time. Or at least that’s what you’ve been told.

There’s a vast financial industry with a vested interest in convincing you that to be a successful investor you have to:

  • Follow the daily movements of the markets.
  • Learn how to analyze the nitty-gritty details of stocks and bonds.
  • Buy and sell constantly to maximize profit.

The truth is that none of this matters. The truth is that smart investing is simple. And easy.

Most investors are best off putting their money into low-cost index funds. (An index fund is a mutual fund that tracks the broad movements of a stock-market index, such as the S&P 500.) Over the long term, this passive investing approach has been shown to produce above-average returns for patient investors. Why? There are many reasons, but primarily because investing in index funds costs much less than nearly any other method.

In fact, Stanford University professor William Sharpe famously demonstrated that passive investing with low-cost index funds must produce better results than traditional investing. The average return of both methods is the average return of the market. But because traditional investing costs so much, investors taking that path necessarily see smaller returns on their investments.

But there are other ways to explore passive investing besides index funds.

Three years ago, I read a book called Fail-Safe Investing by Harry Browne. This tiny volume, first published in 1999, champions a method of passive investing that Browne called the Permanent Portfolio. And while it’s a little more complicated than simply investing in index funds, the ideas are still fairly simple.

According to Browne, the Permanent Portfolio should provide three key features: safety, stability, and simplicity. He argues that your permanent portfolio should protect you against all economic futures while also providing steady returns. It should also be easy to implement.

There are many ways to approach safe, steady investing, but Browne has some specific recommendations:

  • Hold 25% of your portfolio in U.S. stocks, to provide a strong return during times of prosperity.
  • Hold 25% in long-term U.S. Treasury bonds, which do well during prosperity and during deflation (but which do poorly during other economic cycles).
  • Hold 25% in cash in order to hedge against periods of “tight money” or recession.
  • Hold 25% in precious metals (gold, specifically) in order to provide protection during periods of inflation.

To use the Permanent Portfolio, you simply divide your investment capital into four equal chunks, one for each asset class. Once each year, you rebalance your portfolio. If any part of your portfolio has dropped to less than 15% of the whole, or grown to over 35% of the total, then you reset all four parts to 25%.

That’s it. That’s all the work involved.

Because this asset allocation is diversified, the entire portfolio performs well under most circumstances. Browne writes:

The portfolio’s safety is assured by the contrasting qualities of the four investments — which ensure that any event that damages one investment should be good for one or more of the others. And no investment, even at its worst, can devastate the portfolio — no matter what surprises lurk around the corner – because no investment has more than 25% of your capital.

Browne’s arguments sounded crazy at first — far too simplistic! — but with time, I’ve come to believe he’s on to something. In fact, over the past three years I’ve gradually realized that what I need to is move from investing in index funds to establishing a permanent portfolio for myself. Why haven’t I done so?

The high price of gold, for one. Plus, I’ve never really been sure how to implement Browne’s Permanent Portfolio in real life. I mean, what are the actual steps for making it happen? Fail-Safe Investing is a good book, but it’s long on theory and short on actual details. I’m not a professional investor; sometimes I need to have somebody hold my hand.

That’s where a new book comes in.

The Permanent Portfolio: Harry Browne’s Long-Term Investment Strategy by Craig Rowland and J.M. Lawson is an easy-to-access how-to manual for putting Browne’s investment strategy into practice. This book doesn’t just cover the theories behind this method; it also gives details for putting the theories to work in the Real World.

Here is the promotional video Rowland put together for his book.

Nobody knows where the economy is headed. Nobody knows if economic prosperity looms on the horizon — or if we’re in for decades of rampant inflation. And because nobody knows what’s ahead, nobody knows the best way to save for retirement (or any other purpose).

But with the Permanent Portfolio, you don’t have to see the future. You don’t need a crystal ball to divine the best place to put your money. Instead, you hedge your bets against all possibilities. Sexy? Nope. Safe? You bet. And now that Craig Rowland and Mike Lawson have explained exactly how to put the Permanent Portfolio into practice, I intend to do so. Perhaps you will, too.

Note: This essay originally appeared as the foreword to Rowland and Lawson’s book.

1 moom December 3, 2012 at 05:06

The Permanent Portfolio has performed very well since 1982 because that was the peak year of inflation in the US and since then inflation and interest rates declined. This meant that bonds did very well throughout the period. For the first part of the period the stock market also did well (till 2000) and since then gold has done well. Going forward, bonds have to do worse really than they have because interest rates can hardly get lower (capital value of bonds rise when interest rates fall). The portfolio also has only US assets, which seems short-sighted. I believe that a diversified approach is good – just buying stock index funds is a more risky approach – but this particular version of diversification doesn’t look like being the best going forward and there are approaches that have done better over the historic period since 1982. Also Sharpe’s statement about passive management beating active has a lot of caveats… For most investors though it is probably easiest to diversify a lot using passive investments for a lot of the asset classes.

2 Stephen December 3, 2012 at 11:46

Sometimes you seem to have a crystal ball. Spent the last few weeks trying to put together information like this to setup my own portfolio.

I do agree with Moom that diversification should be beyond on US asset classes. Spreading things around the world is a good enough bet, but not overly feasible until the portfolio grows.

3 jlcollinsnh December 5, 2012 at 05:58

Hi JD….

Sounds a bit like my own concept:
50% VTSAX for growth and a bit of income
25% VGSLX for inflation protection and income
25% VBTLX for deflation protection and income

I also keep a cash position that rises and falls according to my anticipated needs.

I prefer the REIT (VGSLX) over gold because it is income producing as well as having the potential to rise in value.

All are Vanguard index funds making this very cost effective and the soul of simplicity to implement.

If anyone cares, details here:

Hope putting up the link is OK. If not, just delete it. :)

Looking forward to our conversation later this week.



4 Joe @ Retire By 40 December 5, 2012 at 08:20

I think 25% in cash and 25% in precious metal is way too much. I doubt many well to do families follow this permanent portfolio recommendation. This is probably good for the average paycheck to paycheck American family.
I need to do more research on this.

5 Peter December 6, 2012 at 07:02

I agree with Joe. 25% in cash and 25% in precious metals seems entirely too high.

6 rubin pham December 6, 2012 at 10:49

i like these advices although i would not keep 25% in cash and 25% in gold. everyone is different and this is especially true if when it comes to cash and gold.

7 Will December 6, 2012 at 14:06

First, to get it out there, I am a financial advisor by profession so read into the following what you will.

While I believe there are several issues with this particular strategy one of the larger ones is it completely ignores the reasons for investing in the first place. The acquisition of wealth is typically not the ultimate reason someone is investing. Instead, people invest to provide for their retirement, funding education expenses for themselves or their families, funding large purchases (such as cars, homes), and so on. This portfolio does not account for any variability of risk or return. Therefore, by design, it will not align with the reasons an individual is putting capital to work in the first place, other than by chance. Have thirty years until you plan to retire? Have only one? No problem! You get the same asset allocation!

Smart investing is not simple. Nor is it easy. To think otherwise is delusion.

Personally, my investment philosophy also embraces a passive approach when it comes to security selection. However, that is only a small portion of the overall process. Prior to even starting security selection an individual needs to consider asset allocation and that is precisely where this strategy fails. Simply put, one size does not fit all, yet that is precisely what this portfolio will deliver. It assumes all investors require the same rate of return and have the same emotional response to financial risk.

8 bluecollargoldtieguy January 23, 2013 at 09:20

This portfolio strategy is not for everyone. It is only for those who seek decreased overall volatility, steady performance, reduced exposure/dependency on the solvency of institutions and who those who are more concerned with the return of their money than a return on their money. Truthfully, this strategy was never designed to be the whole of the portfolio, (hence the distinction of ‘permanent’ as opposed to impermanent). This is only for the part of your portfolio that you aren’t prepared to lose. To understand it fully you must be clear on the delaying of consumption motive, (ie. saving). Sadly, most people have lost sight of this value and are literally paying the price for it.

9 Michiel January 28, 2013 at 06:42

Just finished the original book from Harry Browne, and while it is a great read, I recognise there is some extra info needed to put it into action.
I would like to follow up on your recommendation from Rowland and Lawson, there is that holds me back a bit. As I am european, i am afraid the book will come with a lot of practical advice which is great in the states, but will it hold it’s practical value as soon as somebody in europe wants to adopt these tips?
Any european maybe, which has been reading the Rowland & Lawson version of the permanent portfolio and tried to put it in to practice?

10 PG February 1, 2013 at 12:45

I’ve just finished reading this book, whereas my impression of the other commenters is that none of them have read it. It’s easy to dismiss an investment approach when you don’t understand it. As simple as it appears on the surface, the PP is based on a sophisticated understanding of economics. Show me another investing approach that lost a mere 2% in 2008 when the financial system was collapsing all around us, or that has only had a drawdown in 4 of the last 40 years (the worst of which was less than a 5% loss), or that has averaged a 9.4% annual return for 40 years running. This is an investing approach designed to protect your hard-earned wealth no matter what the economy is doing. To address specific questions raised above:

* The PP is all about *investing*, not *speculating*, which is what most people do with their money that they’re saving for retirement or other expenses. (If you don’t understand the difference between investing and speculating, read the book. That means you too, Will.)
* As non-intuitive as it seems, holding 25% cash and 25% gold are *critical* to the success of the PP, since the whole approach is to take advantage of whichever of 4 economic cycles we’re experiencing, while protecting you from a catastrophe if any one cycle is severe.
* The book explains why REITs are *not* a substitute for gold.
* The PP allows for holding some foreign stocks (that is, stocks that are foreign to you, wherever you may live).
* The PP does not mandate you put *all* of your wealth into it, only the money you can’t afford to lose. Anything else you wish to speculate with can be placed in a separate “Variable Portfolio”.
* The book provides details on how non-U.S. citizens can implement the PP (and in some ways can actually do it better than U.S. citizens).

In summary, I encourage you to read this book. Pick one up at your local library if you want to save yourself the cost of the book. But please read it.

11 S February 8, 2013 at 14:03

I just love how so-called experts come on here and act like they are smarter than Harry Browne and his PP. This is why most people lose money in the stock market. They are led to believe that investing is “complicated” so you need an “expert” to handle your money.

It’s an absolute lie. Look at all the people on this thread acting like they are superior to Harry Browne’s “simplistic” approach yet none of them have annual returns over the last 30 years that can beat the PP approach.

The PP’s results speak for itself. Go look at the past 30 year performance of the PP. It’s about an average of 9% per year and that’s while carrying very low risk.

The “know-it-alls” in this thread are the people who will lose your money. Don’t ever trust these people who say they are “smarter” than a proven track record and they say investing is “complicated” so “trust me with your money”.

It is not complicated. The PP makes perfect sense for a conservative a approach that has proven to give you consistent returns.

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