The Permanent Portfolio by Harry Browne – Component Returns Correlation Analysis and My Future Plans

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This past Monday, Flexo from Consumerism Commentary was very gracious to feature a guest post written by me analyzing whether or not investors can/should use the late financial adviser, Harry Browne’s, Permanent Portfolio asset allocation strategy as a way to obtain market-beating returns. If you haven’t yet read the post, you can stop by and have a look at the link below:

Can Investors Use The Permanent Portfolio to Beat the Market?

In order to improve the ease of reading and keep the focus centered in the guest post, I decided not to include several side analysis portions of the original piece I put together when I was researching the Permanent Portfolio topic. As such, the purpose of this post will be to fill in some of these gaps and give some added information on the following subject areas relating to the Permanent Portfolio that were not included in the guest post:

  • A correlation coefficient matrix analysis of the returns of the various components of the Permanent Portfolio I defined the the Consumerism Commentary guest post.
  • An explanation of my future plans for using the Permanent Portfolio, given the conclusions I arrived at in last week’s guest post above.

What is the Permanent Portfolio? – A Quick Review

For those of you that are hearing about the Permanent Portfolio for the first time, I just wanted to give a quick review about what it involves/does not involve.

  • Permanent Portfolio Goal:  There are two types of money – money that you can afford to lose and money that you cannot afford to lose. The goal of The Permanent Portfolio is to provide safety and stability to the money you cannot afford to lose in any economic climate.

  • There are four broad movements to cover pretty much any economic climate – prosperity, inflation, tight money/recession, and deflation.

  • The Permanent Portfolio is a passively managed asset allocation strategy constructed by components in such a way that at least one component is favored by any of the broad movements mentioned above. The Portfolio components are as follows, each carrying equal weight for as long as you hold the Portfolio:

    • 25% in stocks, which do well in times of prosperity. Harry recommends that an investor select three index mutual funds to make up this portion of the portfolio. However, index mutual funds and ETFs have improved in recent years, and I now believe that an investor could do this quite effectively with a single fund. It’s important to note that he only mentions that the components should “represent the entire market.” He did not specify whether or not this meant the entire international stock market, or just that of the US. We’ll touch on this more below:

    • 25% in gold, which does well in times of inflation, in the form of buying actual bullion coins. 

    • 25% in bonds, which increase in price during times of deflation, in the form of actual 30 year year long-term US Treasury Bonds. 

    • 25% in cash, which does well in times of tight money/recession when interest rates rise. Harry recommends investing in a money market mutual fund that invests only in short-term US Treasury securities.

  • Rebalancing – Harry recommended that the portfolio be rebalanced once a year back to the 25% allocation targets, but only if a specific component is greater than +/- 10% off from target. 

Before we move on, I think it’s important to realize that Browne’s goal for creating The Permanent Portfolio was not, in fact, to create a strategy that would beat the market; it was to provide safety and stability to the money you deem that you cannot afford to lose.

“Refined” Permanent Portfolio Component Return Correlation Coefficient Matrix Analysis

In the guest post, after reviewing existing studies that have analyzed the Permanent Portfolio and defining areas where I’d like to improve the analysis to make it more convincing to me personally, I examined the performance of the “Refined” Permanent Portfolio (consisting of the components listed below) compared to a 100% stock and 75% stock/25% bond portfolio.

  • 25% in stocks – Vanguard S&P 500 Index Fund (ticker symbol: VFINX).
  • 25% in gold. Vanguard Precious Metals and Mining Fund (ticker symbol: VGPMX).
  • 25% in bonds. Vanguard Long-Term Treasury Fund (ticker symbol: VUSTX).
  • 25% in cash. Vanguard Short-Term Federal Fund (ticker symbol: VSGBX).
However, aside from overall return performance (shown in the Consumerism Commentary guest post), yet another very fascinating aspect of The Permanent Portfolio from a Modern Portfolio Theory and diversification perspective is that it’s one of the most diversified portfolios one could possibly find.

What does the fact that this “Refined” Permanent Portfolio is highly diversified indicate for investor returns? Essentially, this means that the returns of each of the components of the Portfolio (stocks, bonds, precious metals, and cash) move in directions independent of one another. In other words, when one of the assets is going down in price, another one is increasing or staying the same, thus preserving your capital as an investor. Perhaps not by coincidence, this is exactly what Harry Browne was aiming for when he constructed the Portfolio components. 

This diversification can be readily observed by examining the table below. Shown in the table are the correlation coefficients of the respective annual returns of the various “Refined”  Permanent Portfolio components (measuring the extent to which the annual returns are related) over the past 20 years. Values that are further from 1.00 indicate lower degrees of correlation between the returns of each component.

As can be seen in the table below, the majority of the components have correlation coefficients between each other of less than 0.20, with three of the relationships having negative correlations. The highest correlation coefficient is 0.68 between the two fixed income assets, long-term bonds and short-term bonds, which is somewhat to be expected since they are in basically the same asset class/family.

My Future Plans With The Permanent Portfolio

After performing the analysis and listing my conclusions in the Consumerism Commentary guest post, I ultimately conclude that I believe few investors (myself included) will have the resolve to stick with the Permanent Portfolio strategy long-term, due to the low correlation that the strategy has with the overall stock market.
As such, I do not plan to fully adopt The Permanent Portfolio in my investing strategy. However, I was intrigued enough by this technique and convinced of its efficacy to adopt it in a smaller manner.

Listed below is how I have adopted this technique to my investing strategy in this limited fashion (test run) using <1% of my overall investing funds. 

It’s important to note that since I’m adopting this investing strategy using a relatively small amount of funds, I elected to use ETFs instead of mutual funds, since ETFs do not carry the $3000 minimums that many mutual funds do. 
  • Stock Portion –  17.5% of portfolio funds invested in the Vanguard Total Stock Market ETF (ticker symbol: VTI) and 7.5% of portfolio funds invested in the Vanguard Total Int’l Stock Index ETF (ticker symbol: VXUS). These ETFs invest in securities in a manner that tracks the performance of the broad US and all-world ex-US stock indices, respectively, and therefore, represent the entire market, as Browne intended.

  • Gold Portion – 25% of portfolio funds invested in the iShares Gold Trust ETF (ticker symbol: IAU). This ETF’s goal is to match the price movements of physical gold bullion. I had considered using the other gold ETF, GLD, but I found that it’s expense ratio was higher than the iShares ETF. 

  • Bond Portion – 25% of portfolio funds invested in the Vanguard Long-Term Gov’t Bond Index ETF (ticker symbol: VGLT). This ETF tracks the price movements of an index of long-term (>10 years) US Treasury and US Government agency fixed-income securities

  • Cash Portion – 25% of portfolio funds invested in the Vanguard Short-Term Gov’t Bond Index ETF (ticker symbol: VGSH). This ETF tracks the price movements of an index of short-term US Treasury and US Government agency fixed-income securities.

Since adopting this “test run” of the Permanent Portfolio in mid November 2011, it has returned ~3.5% vs. a ~13% return of the S&P500, but with nearly half of the volatility/standard deviation, as would be expected with the Permanent Portfolio. It will be interested to keep following the progress of this small test run of the Portfolio! 
The complete set of calculations of the historical performance of the “Refined” Permanent Portfolio, correlation coefficients matrices, and price history of the proposed ETF Permanent Portfolio analyzed in this post and the Consumerism Commentary guest post can be accessed and downloaded at the Google Docs Spreadsheet link below: Note: All performance data was sourced from Yahoo Finance.

How about you all? What are your thoughts about The Permanent Portfolio strategy and concept? Do you think that it will continue to perform well in the next 20 years?

Do you feel it’s something you would implement in to your investing strategy, given the body of evidence available? What do you think about my idea to give it a small test run?  

Share your experiences by commenting below!

About the Author Jacob A Irwin

Hi folks! My name is Jacob. I am the owner and operator of My Personal Finance Journey. I started this blog in January of 2010 and have enjoyed the journey ever since. Since finishing up graduate school in Virginia in 2014, I have been working in biopharmaceutical development in Colorado. You can read more about me and this site here​. Please contact me if you have any questions!

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Leave a Comment:

Rob Bennett says March 3, 2012

Do you feel it's something you would implement in to your investing strategy, given the body of evidence available? What do you think about my idea to give it a small test run?

I find it interesting that your reaction to PP is similar to your reaction to Valuation-Informed Indexing — that it has some theoretical appeal but that you are hesitant to adopt it as your own strategy. I think this makes sense. Both of these strategies are rooted in assumptions very different from the ones that drive Buy-and-Hold strategies. Both reject the efficient market concept. Both reject Modern Portfolio Theory.

The reason why you are reluctant is that making the change means abandoning all your current investing beliefs. That's a big jump for someone to take! It's like asking someone who has been married for 20 years and has five kids to get a divorce and start life over.

What we need to do today is not to ADOPT these strategies (most of us are reluctant to make a jump that big) but just to DISCUSS them. By discussing them, we will over time either lose confidence in Buy-and-Hold and GRADUALLY come to have confidence in the new ideas or will over time gain reassurance that Buy-and-Hold is really the way to go.

In both cases, you have toyed with the idea of part-way adoption of the new strategies. But that is very hard to justify. If the efficient market concept is right, Buy-and-Hold is really the way to go and it is a mistake to limit your stock allocation to 25 percent. But if the PP or VII really are the way to go, the theoretically proper thing to do is to invest your entire portfolio according to their principles.

The bottom line (in my view!) is that we just do not know all there is to know about investing today. We have to for the time-being go with what we think is best. But we also need to keep our minds open enough to continue exploring new ideas (something you do a great job of at this blog!).

My recent post Financial Highway Column #7 — The Three Deadly Illusions of Stock Investing

lizziebxtn says March 13, 2012

I think getting to grips with assets has been something that I have had trouble getting my head around in previous years. When it comes to portfolio analysis I definitely have strategy set in place for the various economic climates. Inflation, especially is a priority for me but we never know what is going to happen. I think the best thing to do is stay informed so that you can make the right decisions for yourself.

Bob Richards says June 20, 2013

I know that the mantra is investing is diversification. But diversification is a guarantee of mediocre returns, as is the permanent portfolio. (Worse, the correlation of the 4 categories are not consistent over time). I would encourage all to read William Oneil’s book “How to Make Money in Stocks” based on rigorous research.

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