Investing For Early Retirement: Permanent Portfolio

Investing is an important topic when planning for financial independence, mostly attributed to the fact that money stuffed under your mattress will not provide the income you need! If you plan to save a chunk of your cash, and live off of the income it produces, then you will need to manage your money for a living, and good management can be the difference between success and failure. There are countless different investing strategies and tactics devised, thousands of books written, and millions of web pages created. There have to be hundreds of thousands of different investing strategies and tactics out there, and if that wasn’t enough, they usually don’t agree on what is best! Many of them even conflict with each other! This can make investing seem complicated, and there is a lot to educate yourself about in order to make good decisions. However, that doesn’t mean there are not well designed strategies out there that can simplify things. Some strategies require constant watch on the markets, companies, and the news. They require you to devote endless amounts of time and energy into analysis, just to slightly beat the market. These strategies form a lifestyle around investing, and force investing to be a large part of your life. Others are an almost completely hands-off approach like index investing, or dogs of the dow. So how do you choose one that will allow you to live off of your investments AND allow you to sleep at night without fearing that your investments will crumble to nothing? It doesn’t have to be complicated, and there is one truth that should save you from many financial mistakes.

You Cannot Predict The Future

This is how I picture most guru’s get their predictions.

And nor can financial analysts, wall street “gurus”, or the guy who just sent you that newsletter with the hot tip for a penny stock that will give you 1000% returns. They are all speculating, and they are not investors. NOBODY CAN PREDICT THE FUTURE! Accept this and your investing career will be more prosperous.

Speculating: Making purchases based off of what you think will happen at a future point in time. You choose sector specific assets in hopes that it will beat the market. This is akin to gambling, and involves too much emotion.

Investing: Making purchases based off of rational arguments, and with no attempts to ‘time the market’. Creating a diversified portfolio that can do well in any economic climate, as you accept that you do not know what the future holds. This is a safer path to long-term wealth.

If you research and pay attention to the advice of analysts you will notice that at any point in time you can find multiple analysts with conflicting recommendations. At first, this drove me crazy as I could always find good logical arguments for either side, but never anything conclusive. Clear this mess from your investing life and accept that they are trying to be fortune tellers. They speculate, and you invest. Eventually you’ll come to notice that conflicting analyst opinions makes you more confident in the permanent portfolio. This is because you start to realize that their opinions are not based off of fact, but rather opinion. They are both looking at the same crystal ball, but one of them is looking at it upside down, and neither fully know what they are doing!

The Permanent Portfolio

Harry Browne has created a logical structure for a portfolio based on sound economic theory. He wrote Fail-Safe Investing: Lifelong Financial Security in 30 Minutes, which is a great read for anyone interested in the permanent portfolio. The entire book is based off of two assumptions, and logically structures a robust asset allocation based on the assumptions. The two core assumptions are:

  • You cannot predict the future.
  • The market is always experiencing one of four conditions: Prosperity, Inflation, Deflation, and Recession.

The allocation that was birthed from these assumptions is deceptively simple. You own four assets equally, each making up 25% of your portfolio.

The four assets are chosen based on their historic responses to certain market conditions, and they are:

  • Stocks: Stocks do well during periods of prosperity and growth. Currently I hold XIC, which is an index fund holding the 250 largest stocks by market capitalization on the TSX. It has an MER of .27%.
  • Long Term Bonds: Long term bonds do well during times of deflation. Best held as long term 30 year government treasury bonds. I hold ZFL for convenience, since I plan to liquidate soon to use as a downpayment on my rental property. ZFL holds long term Canadian Government Bonds.
  • Gold: Goes up during periods of inflation. Best held as physical bullion. I hold GTU.UN, again for convenience. But if shit hits the fan, you’re going to want physical gold for bartering!
  • Cash: Cash is for recessions. You will need to cash to buy the heavily discounted things people will be selling (since they didn’t have cash!). A great safety net. Having cash allows you to make purchases when others cannot. I opt to hold my cash as short term bonds. This slightly increases my returns while adding risk. I have many jobs providing good cash flow constantly for buying opportunities. I will eventually set up a bond ladder of 1-3 year bonds. Currently, I hold ZFS instead of actual short term bonds.

These assets do not correlate with each other, and generally has assets performing poorly being offset by assets performing well. While one asset is falling, another will be climbing.  You do not know what is in store for the future, so you prepare for every situation. The allocation historically has low volatility and 10% annual returns on average. This is a very attractive option for an investor who does not want to engulf themselves in market news, company politics, and analyst predictions in an attempt to beat the market. It requires next to no effort once it is set up, allowing for an almost totally hands off approach once it is set up.

 

PermanentPortfolio.1972-2011 (Credits to www.crawlingroad.com)

Credits go to Craig Rowland for creating this graph! He also wrote a book titled “The Permanent Portfolio”.

To set up the portfolio, you simply acquire equal amounts of the four assets with your funds. It is not necessary to attempt to ‘time the market’ with your entrance, as that is speculating. You can simply buy all four assets at once. Over time, as the markets shift around, some assets will perform well while others under perform. This will cause your asset allocation to fall out of balance, and this is where some magic is hidden. A forced buy low, sell high situation. As an asset falls below 15% or climbs above 35% of your total asset allocation, then you rebalance. These are sometimes referred to as the 15/35 balancing bands. Changing the bands has not shown to significantly impact the portfolio. Some people choose to use 20/30 bands but I like 15/35.

Some also choose to modify the base asset allocation, but permanent portfolio purists would argue that you are now speculating. For example, if we are in a recession, it is likely for stocks to have a growth period soon, and thus you may want to have 40% invested into stocks, with 20% in the other assets. I would recommend against this, but there is indeed a solution for those who can’t resist some speculation! You can create two seperate portfolios: A “pure” permanent portfolio, and a Variable Portfolio. You can choose to allocate 80-90% to the permanent portfolio, and 10-20% to the variable portfolio. Some choose to have their variable portfolio dedicated to dividend paying stocks. Be prepared to lose ALL of the money in your variable portfolio at any time. Do not put money you can’t afford to lose into the variable portfolio! If this suits you, go for it!

There are incredible resources for this portfolio online here at Craig Rowland’s website. These forums, this thread, and it’s continuation thread are also incredible resources that I have found particularly useful.

Another great resource, but not free, is Craig Rowlands Book, The Permanent Portfolio: Harry Browne’s Long-Term Investment Strategy
It is an update to Harry Browne’s original book. I have not read it myself, but based on his blog, I think it would be a terrific read. I will be ordering a copy!

These sources will probably able to answer every question you’ll ever have about the permanent portfolio, and it is covered in much greater detail.

Parting Thoughts

As a disclaimer, I am not a financial advisor, nor do I have any intentions of being one. This is purely an informational blog post about my chosen investment method. I do not know if the future will be the same as the past!

That said, I do feel confident that if this portfolio fails I will have much more to worry about than my money. My life would probably be in danger. This is why we should all be able to self-sustain ourselves.

Invest at your own risk, and ALWAYS do your own research before purchasing ANYTHING!