I wrote a few months ago that the 60/40 portfolio is dead.
“Dead” might have been a little harsh, but with bond yields as low as they are today and stocks close to hitting new all-time highs, a portfolio that is invested 60% in stocks and 40% in bonds isn’t likely to generate the kind of returns we’ve come to expect.
But what about that old relic of the 1980s, the Permanent Portfolio?
The Permanent Portfolio was a concept popularized by the late Harry Browne, a writer, investment adviser and two-time Libertarian presidential candidate. The portfolio is simple yet elegant. Because you can’t know with perfect foresight what sort of economy you’ll be living in, you have to plan for everything: inflation, deflation and everything in between.
Browne divided his Permanent Portfolio into four equal parts: stocks, long-term bonds, cash and gold, and he rebalanced it annually with the idea that there’s always a bull market in something.
Stocks tend to do best during times of stable prices and solid economic growth. Long-term bonds do best during times of falling inflation and during recessions. Gold is a natural inflation hedge and does best during times of rising prices or currency instability. And cash is the ultimate crisis hedge, giving you that all-important dry powder when you need it.
The Proper Permanent Portfolio Allocation
The Permanent Portfolio is simple. You can put it together with just four ETFs: The Vanguard Total Stock Market Index Fund ETF (VTI), the iShares 20+ Treasury Bond ETF (TLT), the SPDR Gold Shares (GLD) and the SPDR Bloomberg Barclays 1-3 Month T-Bill ETF (BIL), a substitute for cash.
Once a year, you sell down the ETFs that have moved above their 25% weight and buy more of the ETFs that have drifted before. The idea is that the Permanent Portfolio will always have you buying low and selling high.
That sounds good. But does it work in the wild?
Indeed it does.
In the six months up to May 31, the Permanent Portfolio based on these ETFs returned 8.5%. You would have never known there was a world-ending pandemic just a few months ago.
Over the past three, five and 10 years, the Permanent Portfolio would have returned 8.8%, 6.8% and 6.7%, respectively.
Now let me be clear: The Permanent Portfolio is not perfect.
It’s completely arbitrary to set each portfolio weighting at exactly 25%, and 25% allocated to cash is an awful lot of permanent dry power for most investors. It wouldn’t be hard to build a better mousetrap based on the same basic principles, and that’s exactly what Ray Dalio did to grow his firm Bridgewater into the largest alternatives manager in the world.
Dalio’s $160 billion hedge fund essentially just runs a more sophisticated version of Browne’s Permanent Portfolio.
That said, there are a couple of aspects of Browne’s portfolio that I think are particularly well-suited for this climate.
To start, it’s really heavy in gold. With the Fed essentially determined to print its way out of the COVID-19 crisis, I think it’s very likely we get inflation and dollar instability in the coming years, which is wildly bullish for gold.
I also expect a lot of volatility in the months ahead. So, that large 25% cash cushion suddenly seems a lot more reasonable.
I would recommend deviating from the standard Permanent Portfolio in one key way, however. Be willing to rebalance more often than once per year. An epic market crash like March of this year would have been a fantastic time to rebalance and put some of that cash to work.
Charles Lewis Sizemore, CFA is the principal of Sizemore Capital Management, an RIA based in Dallas, Texas.