Introducing the Permanent Portfolio

When Scott Burns created the original Couch Potato portfolio back in 1982, he suggested that investors put half their money in an S&P 500 index fund, and the other half in a bond index fund. At the time, that was a revolutionary approach to investing. It was based on the idea that picking stocks and forecasting the economy are futile, and that investors would be better off simply buying entire asset classes in equal amounts, and holding them at all times.

But the Couch Potato wasn’t entirely original. The year before, an American investment analyst and libertarian named Harry Browne co-authored a book called Inflation-Proofing Your Investments, in which he laid out his own passive strategy based purely on asset allocation. Browne suggested dividing your money equally among stocks, long-term government bonds, gold and cash. He called it the Permanent Portfolio.

When Browne created the Permanent Portfolio in the 1980s, it wasn’t particularly easy to manage on your own. (A mutual fund version of the of the Permanent Portfolio was launched in California in 1982 and is still going strong, albeit with a more complex asset mix that includes silver, Swiss francs and real estate.) There were a few equity index funds, but you would have had to buy individual Treasury bonds and gold coins.

Today, the strategy has gained a following among do-it-yourself investors, since it’s easy to build and maintain a Permanent Portfolio with ETFs. For Canadians, it might look like this:

12.5% iShares S&P/TSX Capped Composite Index Fund (XIC)
12.5% iShares MSCI World Index Fund (XWD)
25% BMO Long Federal Bond Index ETF (ZFL)
25% iShares Gold Trust (IGT)
25% any CDIC-insured investment savings account

A child of the 1970s

It’s not surprising that Browne’s idea arose when it did. The bear market of 1973–74 was horrendous, and sky-high inflation meant that real returns on both equities and bonds were negligible during the decade (remember The Death of Equities?). President Nixon also took the US off the gold standard in 1971—before that, an ounce of bullion was fixed at $35. As soon as it was allowed to float, the price of gold skyrocketed: 49% in 1972, over 70% in both 1973 and 1974, and 136% in 1979 (all figures in US dollars). During a period like that, it’s easy to see the appeal of moving beyond traditional portfolios of stocks and fixed-income.

But not long after Browne introduced the Permanent Portfolio, stocks began a charging bull market that would last for some 18 years, until the dot-com bubble burst in 2000. Gold performed horrendously during this period, and the Permanent Portfolio lost its shine as investors fell in love with equities again.

What’s gold is new again

Now we’ve come full circle. Despite another bull market from 2003 through 2006, the returns on stocks over the last dozen years have been dismal, while gold has regained its lustre. The Permanent Portfolio mutual fund posted an annualized return of 11.8% over the 10 years ending June 30, and even managed to eke out a small positive gain in 2008, when just about everyone else took a bath. With stocks in the toilet again this summer—and gold up about 30% year to date—I expect it will begin attracting interest once again.

With this in mind, I wrote about the Permanent Portfolio in my most recent column in MoneySense, and interviewed Craig Rowland to get his insights. Craig, a DIY investor in Portland, Oregon, has kept Browne’s ideas alive on his website Crawling Road. He writes a blog about the Permanent Portfolio’s ongoing relevance, hosts a discussion forum about the strategy, and has even archived episodes of Harry Browne’s radio show, recorded in 2004 and 2005, shortly before Browne’s death. They’re well worth a listen if you’re interested in learning more.

Later this week, I’ll share some highlights from our chat. While I’m not ready to adopt the Permanent Portfolio myself, I do find it a fascinating idea, and index investors can learn a lot from what Craig has to say. Stay tuned to see what Browne can do for you.

36 Responses to Introducing the Permanent Portfolio

  1. Jim August 29, 2011 at 10:32 am #

    What about using XRB instead of ZFL?

    ZFL does have a lower Mer., But XRB has bonds with an average weighted duration of 16. 3 years and ZFL has 14.17 years. I think Browne liked using a longer bond. XRB bonds are also inflation protected – they are Real Return bonds.
    ZFL is all federal bonds, so in theory it is more secure than XRB which also has some provincial bonds.

  2. Glenn August 29, 2011 at 1:47 pm #

    I was wondering if there is any good way of investing in gold for people who hold only mutual funds? I have the TD e-series funds and have been working on getting them set up with a mix of CAD, US and Bonds. But how could I go about buying gold if I wanted to?

    Thanks so much for your insight and for your always interesting blog.

    All the best!

    Glenn

  3. The Dividend Ninja August 29, 2011 at 7:33 pm #

    Dan, fabulous post!

    Nice to come across this book again, which I’ve since misplaced. I remember reading Browne’s book back when I was 28, but unfortunately I wasn’t smart enough to adopt it ;) Looking back since then, this has been a stellar-portfolio over the years and during the different economic cycles and market swings we’ve experienced. With this portfolio there is always a given that 25% or more of your portfolio is in a top performing asset class. And if bonds, stocks and gold should be losing assets at any given time, then you haev 25% of your portfolio in cash – times like those “Cash is King.”

    I like the concept, but wouldn’t want to be buying Gold at the moment. I had lost this book, but am going to order it again (you will be able to feed your family now from the Amazon commission).

    Cheers!

  4. Canadian Couch Potato August 29, 2011 at 10:03 pm #

    @Glenn: There are some mutual funds available that invest largely in gold, such as those from BMG Bullion, but the fees are so high (3%) that I would not recommend them.

    @Ninja: Good luck finding a copy of Browne’s book. Only ratty old second-hand copies still in print!

    @Jim: Harry Browne was adamant that inflation-protected bonds were not appropriate for the Permanent Portfolio. They will behave very differently from nominal bonds. Remember, the long-term bonds are there to protect you from deflation, and RRBs will be dogs during periods of deflation.

  5. Jim August 29, 2011 at 11:00 pm #

    You can still get Harry’s latest book on this topic from Amazon.
    “Fail-Safe Investing: Lifelong Financial Security in 30 Minutes”

    “Why the Best-Laid Investment Plans Usually Go Wrong: And How You Can Find Safety and Profit in an Uncertain World ” is from 1989 and goes into more detail on the reasoning behind the portfolio. You can find copies for around $8, including shipping, from AbeBooks.com.

  6. Jim August 29, 2011 at 11:04 pm #

    Read what William Bernstein has to say about this portfolio. He likes it.

    http://www.efficientfrontier.com/ef/0adhoc/harry.htm

  7. Craig Rowland August 29, 2011 at 11:29 pm #

    Hi Dan,

    Thanks for the interview and mention of my blog. I transitioned to this portfolio for US investors after being unsatisfied with other approaches I had investigated. Your responses above are just what I would have said. The assets in the portfolio were chosen for very specific reasons and are based on about three decades of empirical evidence at this point. I find that more trouble is caused by twiddling with the formulation than just leaving it on auto-pilot and letting it do its thing.

    Readers interested should check out Harry Browne’s radio archives, his book Fail-Safe investing (available in an e-book form for about nine bucks). His older books are also great, but I like Why The Best Laid Investment Plans Usually Go Wrong. That book has a lot for more technical details for those interested. Some parts are a bit dated with today’s investment products, but the core ideas are still outstanding.

    – Craig

  8. Jim August 30, 2011 at 12:20 am #

    Inflation protected bonds did not exist when Harry was writing his earlier books. I don’t think you could buy them until well into the 1990′s. His last book published in 1999 does not mention them. (TIPS as they are called in the US)
    But I do understand your point. They don’t strictly fit with his idea of gaining from deflation.
    On the other hand, even during deflation, the purchasing power of Real Return Bonds (RRB’s) would not decrease. Your return would in effect be zero in comparison to their purchasing power. They might go down in dollar value, but would still purchase the same value of goods.
    Your gain during deflation would be from your cash holdings, since the purchasing power of cash would increase during deflation.
    Granted, a portfolio holding RRB’s would not have the same gains as one holding regular long bonds during deflation, but I don’t think it would really do all that terribly when measured by the purchasing power of the portfolio.
    I hesitate to even write this next part, since the point of the Permanent Portfolio is to handle all situations without having to predict the future. But.. an extended period of deflation is extremely unlikely given the stimulus that has been pumped into the economy. Inflation is much more likely (I really hated writing that!!!), especially when considering the debt of the US. The US will want inflation in order to decrease the value of their debt, and they can print dollars endlessly to do that.
    I guess my final point is that holding RRB’s during deflation is not as bad as it might appear, and if you wanted to make a bet on the future, inflation would be the place to put your money. If you don’t want to bet, then don’t buy RRB’s.
    ****Although if you buy regular bonds, you are betting that deflation is more likely than inflation. So maybe we are still trying to predict the future, even if we strictly follow the Permanent Portfolio!!!! :)

  9. Craig Rowland August 30, 2011 at 12:42 am #

    Jim,

    Harry Browne was well aware of TIPS and inflation protected bonds. They have only been in the US since the late 1990s, but have been in other countries for decades. He mentioned them specifically in his radio show as bonds you don’t want to use. Only gold should be held for inflation protection in his portfolio. Nominal bonds are held for deflation protection which inflation indexed products will not provide when needed.

    Keep in mind that the assets are designed to have explosive growth when needed. We don’t want assets to just kind of muddle along when we need them. During deflation inflation indexed bonds won’t lose value, but they also won’t go up +30% the way US Treasury LT bonds did in 2008 when the markets nose dived. TIPS in that year went down in value providing no protection.

    Japan has been trying stimulus spending for over 20 years and it hasn’t worked. Long term bond rates for Japanese still hover around 2% even today. Could happen in the US. But if we get the inflation the Fed desperately wants, you better be holding gold and not inflation indexed bonds because it’s going to be a wild ride in all likelihood!

  10. Canadian Couch Potato August 30, 2011 at 10:14 am #

    Many thanks to Craig Rowland for chiming in with his comments. If you’re interested in the subtleties of the Permanent Portfolio, Craig is your guy. Check out his blog and discussion forum at Crawling Road.

  11. Monte August 30, 2011 at 12:37 pm #

    Just a thought – I wonder what the returns would be (historically) if you reduced the four asset allocations to 20% each, and added a fifth allocation to give you international exposure – say a Vanguard international index fund?

  12. Stephen August 30, 2011 at 4:09 pm #

    While I don’t like the idea of saving for retirement 50% invested in gold and cash, maybe moving toward that as I get older would be good as I’ll be more sensitive to losses. Taking this thought further, would the Permanent Portfolio be appropriate for someone already retired?

    Regarding the long term bond component. Would long term corporate bonds, instead of government bonds, be effective in the Permanent Portfolio?

    Thanks,

    Stephen

  13. Canadian Couch Potato August 30, 2011 at 7:15 pm #

    @Stephen: Personally, I would be a bit concerned about the PP as a retirement portfolio, but you could probably manage by taking income from whatever asset class has gone up the most (i.e. rebalancing with cash outflows). Harry Browne recommended only government bonds, not corporate bonds, because he didn’t recommend taking any credit risk.

  14. My Own Advisor August 31, 2011 at 9:40 am #

    Great post Dan!

    I could see how this strategy could gain a modest following, since the cycle has again repeated, re-living part of the 70′s. Gold has gone up about 300% since 2006 I believe, so it has become a flight to safety. You referenced this very well.

    With stocks in the bowl again, for me, this is the perfect time to be investing in dividend-paying stocks. They aren’t “in favour” with many folks, although the CIBC dividend increase this morning might changes some minds ;)

    In another 10-years, maybe more, maybe less, who knows….the stock-horse on the merry-go-round will come and stocks will in-vogue again. Everyone might be saying I should have bought stocks 10-years from now. The 80′s will repeat just like the 70′s are now. That means inflation is on the way (early 80′s) and I think some dividend-payers are a great hedge against that.

    Having short bonds will be good as well. I’ve never really understood the reason for having long bonds, they act more like equities. ZFL is a long bond so why is this good in an inflationary environment?

    I like government debt personally over corporate debt. Some cash is always good.

  15. Craig Rowland August 31, 2011 at 5:30 pm #

    @Monte – For money you want to gamble you can use a Variable Portfolio. So if you wanted to add 20% into more stocks, consider that your Variable Portfolio. Variable Portfolio money is for money you can afford to lose. Also, under this strategy, you are not allowed to replenish losses in the Variable Portfolio with money from the Variable Portfolio. The Variable Porfolio idea is optional. Peronally, less than 1% of my total investable assets are in Variable Portfolio bets. My core life savings is in the Permanent Portfolio.

    @Stephen – Long Term bonds have credit risk and are not a replacement for government bonds. Unlike the government, corporations cannot print money or raise taxes to make their bond payments so they have more risk. In the US, in 2008 LT govt. bonds went up over 30% in value. LT Corporate bonds all lost value.

    re: Retirement. I have used this portfolio for living expenses and it works fine. In fact, it has allowed me to protect my assets, grow my money, withdraw for living expenses and sleep at night through some really bad markets. I hate seeing retirees taking on a lot of risk in their portfolios with concentrated bets in any one asset. There are risks that can affect any investment, even one we all may think is safe right now. Best to spread the money out far and wide.

    Re: My Own Advisor

    The Permanent Portfolio strategy has rebalancing bands for upper and lower limits. Any asset approaching 35% or more is sold back down to 25%. Any asset that is 15% or less is bought back up to 25%. In this way the portfolio limits losses and is forcing you to sell winners and buy losers. The past year a Permanent Portfolio adherent as likely been selling down their LT bonds and Gold and buying more stocks. In 2007 they were selling their stocks and buying LT bonds and gold. In 2008/2009 they sold the LT bonds and bought stocks at decade lows. So the strategy works fine if you are diligent about rebalancing and are not trying to time the market.

    Long bonds do not act like equities. They act like long bonds! Which means they are not going to move in lock step with stocks. They will move in lock step with interest rates. If interest rates are low and steady that is good for Long Bonds and Stocks. When interest rates are rising it is bad for long bonds and may be OK for stocks to a point and then turn bad. When interest rates collapse then LT bonds do great but it is very bad for stocks (serious deflation). So it all depends what the economy is doing and not what else is going on. The Permanent Portfolio is built around assets that correlate to the economy and not each other. That’s why I feel it works so well no matter what is going on.

  16. My Own Advisor August 31, 2011 at 9:04 pm #

    @Craig,

    Thanks for taking the time to respond.

    Your explanation makes more sense: a Permanent Portfolio adherent as likely been selling down their LT bonds and Gold and buying more stocks. This process of rebalancing would not be any different than what any other prudent investors should be doing, even without a Permanent Portfolio. Maybe I’m wrong here?

    I realize long bonds are not equities, rather, they are certainly not like short bonds either. I guess my point is, I have an affinity to holding shorter bonds myself but I can see how a mixture of bonds is healthy for some investors.

  17. Craig Rowland August 31, 2011 at 10:53 pm #

    @My Own Advisor

    Yes investors should be rebalancing. For the Permanent Portfolio it is especially important because the assets are designed so that one or more may be doing quite well when one or more may be doing quite poorly. So there is this idea of being forced to do contrary things (buying losers and selling down winners) and take your emotions out of the mix. But the end result has been a very consistent low volatility growth over the years. Investors that follow the plan have been rewarded with consistent moderate growth and very low drawdowns in bad markets. Average real rate of return is in the 3-5% range after inflation. This may not sound like much, but there have been protracted periods of time where stock/bond portfolios have had 0% real returns for decade plus periods.

    Long bonds are not short bonds of course. Short bonds function as cash in this portfolio strategy. The long bonds are held to help out in prosperous markets like stocks, but they are also the only asset likely to do well under deflation like we had in the US in the 1930s Great Depression and since 2008. When the markets are expecting deflation LT bonds are absolute beasts and will stomp the living daylights out of anything else you can own.

    But what was funny is that economists and academics would advise against holding LT bonds because, naturally, under our modern monetary system deflation was so unlikely. But of course they were wrong. Which is the point in the portfolio. You hold all the assets all the time because we don’t know what will happen. Harry Browne was fond of saying (paraphrasing): “I’ve never seen an asset priced so high that it couldn’t go higher. And I’ve never seen an asset priced so low that it couldn’t go lower.”

    And, he’s right. The markets are too unpredictable to guess these things so I don’t worry about asset prices and just rebalance. It seems to handle things well enough that there is no need to worry about the future (which we can’t predict anyway). I just kind of ignore my portfolio and it takes care of me.

  18. Dale September 20, 2011 at 5:40 pm #

    but wonder now if corps are safer than governments. govs seem to be on the road to bankruptcy… if the idea was to avoid risk. I wouldn’t touch a US gov bond.

  19. Canadian Couch Potato September 20, 2011 at 6:05 pm #

    @Dale: I think Harry Browne would argue that your forecast is exactly the type of thing the PP seeks to avoid. No one ones what the future holds for US government bonds, or gold, or stocks, and it’s folly to predict.

  20. Dale September 21, 2011 at 6:28 am #

    Thanks. I know it’s odd. It would make you do things you don’t want to do, and know are maybe wrong, but right in total due to inverse relationships. That said, US is on a very predictable path. There are other people who’ve been right, such as Peter Schiff. He’s been right for almost two decades. He’s still right. The US is broke and will have a debt and dollar crisis. I would not hold one US gov.

    Though I agree with much of the portfolio. I advise a few friends and colleagues. I’m at 10% gold, 50% corps cbo, 20% cash and 20% stocks. all etfs with Sprott Canadian equity into the mix. Knock wood, it is holding up very well.

  21. Dale September 21, 2011 at 6:41 am #

    Also on doing the ‘wrong’ thing, it would make you buy long bonds. We all know that long is dangerous when interest rates rise. I’ve reduced everything to short in the cbo. But yeah, I know, the asset class relationships. Gold and stocks cover off the inflation ‘thing’. I do think you can tweak this over a business/economic cycle and get better returns. I will track these moderations for you, during the pending collapse of US and Europe. But I’m a fan of the basic asset allocation.

  22. Dale September 22, 2011 at 12:49 pm #

    Wondering if you could help with a question on the PP. On the crawling road blog and year-by-year breakdown, cash is shown as short-term bonds?

    http://crawlingroad.com/blog/2008/12/22/permanent-portfolio-historical-returns/

    Is that the case? Bonds carry interest rate risks. If you could clarify that would be greatly appreciated. Was that the fund creator’s intention, to have short term as cash component?

  23. Craig Rowland September 22, 2011 at 12:56 pm #

    Dale,

    I use Short Term Bonds as a proxy for cash for two main reasons:

    1) It provides slightly better returns for very little additional risk vs. Treasury Money Market Funds (MMF).

    2) Finding a good Treasury Money Market Fund can be hard, but many fund providers do usually offer some kind of ST Treasury bond fund.

    I recommend you have at least a year’s worth of living expenses in a Treasury MMF for the cash allocation. Then, *optionally*, if you want to get a little more return you can use a ST Treasury bond fund with a duration around 1-1.5 years. The typical Treasury MMF has a duration around 60-90 days for comparison. This again is optional and if you kept all your cash in a Treasury MMF you are still going to be fine. The use of slightly longer ST bonds as part of the cash hybrid has not historically affected portfolio volatility but has provided around 0.5% a year extra return. But again there is nothing wrong with keeping it all in a Treasury MMF. And, if you have less than a year’s savings in cash, you should *only* keep it in a Treasury MMF. You want your cash held in a very safe and stable form for near term needs.

    Hope that helps.

    – Craig

  24. Dale September 22, 2011 at 1:51 pm #

    Hey Craig, thanks for the reply. I currently hold a lot of short term corps cbo, hopefully that will work for my ‘short’ term. Though I hold high interest savings as well.

    My thesis has been close to PP, but only 10% gold. I’m looking to go against my better judgement (ha) and add more gold and long-term (gulp) bonds. I’m fascinated by this portfolio and the returns. One can’t argue with the numbers. Thanks again… I am sending this to many friends and family.

  25. marc October 3, 2011 at 8:05 pm #

    how does one begin this portfolio with minimal funds? would you dispurse your full amount over the 4 categories at once or build the savings account up to a decent amount say 10,000 before you invest?

  26. baba October 5, 2011 at 7:53 am #

    Craig,
    When you say you are living off your PP, are you just living off the interest and dividend returns, or are you also cashing in some of the assets? Further, what would you consider a safe percentage to withdraw per year from this portfolio?
    Baba

  27. Craig Rowland October 5, 2011 at 11:48 am #

    I live off of interest, dividend or capital appreciation. Just depends on the year. Gold for instance doesn’t have interest or dividends so the only way to harvest profits is with rebalancing which I can use for living expenses. I think a lot of investors get focused too much on interest/dividends and forget that assets can also go up in price and provide nice capital gains that can be used. To the portfolio it doesn’t matter as it grows with any of them.

    Safe withdrawal is highly subjective. Anything over 4% is likely playing with fire depending on how long you need the money to last. But staying around 3% seems like a reasonable number that will ensure the portfolio can grow faster than inflation going forward.

  28. Dale October 12, 2011 at 6:40 am #

    Hey Dan, I know that you’re not a believer in gold as an asset class, but what about the long short (or cash) bond theory or the PP? Why not hold long bonds xlb in your couch potato model? With xbb you are unable to rebalance out of long bonds when they go on a good run (as they have). They’re mixed in with some 5-10′s. Isn’t rebalancing at the core of etf model portfolios?

    Interested to hear Craig’s take as well.

  29. Canadian Couch Potato October 12, 2011 at 10:20 am #

    @Dale: A fund like XBB provides exposure to a good cross-section of bonds: roughly 50% short, 25% intermediate (5-10 years), and 25% long. Over time its duration remains pretty consistent (between 6 and 7), so in a sense it rebalances itself.

  30. Dale October 12, 2011 at 1:13 pm #

    Thanks, but is it not true that you cannot rebalance and hence take advantage of protection against deflation to a full degree? I think xbb continually holds the same allotment of duration(s) and hence does not rebalance. As the PP annual returns page shows us lb and sb can move in different directions.

  31. Ryan October 18, 2013 at 11:53 pm #

    In ‘The Permanent Portfolio’ by Harry Browne it is stated that your investments should be country specific, and that mixing may alter the protection that the permanent portfolio offers.

    Why diversify your stock holdings between Canada and World indexes, as you have suggested?

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