Monday, October 24, 2011

Permanent Portfolio vs. PRPFX

I am a huge advocate of investing in the permanent portfolio plan as outlined by Harry Browne in his small book called Fail Safe Investing.  While I would encourage people to pick up a copy of the book if you haven't read it, I'll give a quick summary of the portfolio.

The permanent portfolio is an investment strategy where you allocate your funds as follows:
25% in stocks
25% in long-term government bonds
25% in gold
25% in cash or cash equivalents

The allocation does not have to be exactly 25% each, but it should stay fairly close.  If one of the investments goes up or down quite a bit and starts to get away from the 25% target, then the portfolio should be rebalanced.  For instance, if stocks go up quite a bit and the stock portion of your permanent portfolio is now 35%, you should sell some off to get back to the 25% allocation.  The 10% you have from selling off the stocks should be used to buy the other assets that fell below 25%.

This strategy is designed to perform well (or at least not too badly) in any economic environment.  During a time of prosperity, stocks should do well.  During an inflationary environment, gold should do well (and perhaps stocks to a lesser extent).  During deflation, bonds should do well (along with cash).  In a recession, it is possible that nothing does well except for cash.  However, recessions are usually short-lived and will turn into inflation, deflation, or prosperity.

I recommend putting at least half of your investment money into a setup like the permanent portfolio.  It really should be much more than half unless you are a big risk taker.  While the permanent portfolio is far from perfect, I really don't know of any other buy and hold strategy that is as safe.  Even holding cash is not safe because of the risk of inflation and a depreciating currency.

There is an alternative to setting up your own permanent portfolio.  There is a mutual fund that somewhat mimics it.  The symbol is PRPFX.

I still prefer Harry Browne's permanent portfolio to PRPFX.  The mutual fund takes some extra chances, in my view unnecessarily.  There is a small portion in silver, which is more volatile than gold.  The fund also invests in individual stocks.  Even though the stocks make up a very small percentage, I think it should just buy a broad market index fund and stop picking stocks.

The other thing I don't like about PRPFX is that it invests approximately 10% in Swiss francs.  This makes no sense for someone not living in Switzerland.  The Swiss franc has been thought of as a strong currency, but to me it is playing unnecessary games.

The permanent portfolio invests in 25% gold to protect against a falling dollar.  If you are an American, living in the U.S., then this 25% gold allocation is there to protect you against dollar devaluation.  You don't need another currency, particularly a fiat currency.

In early September of this year, the Swiss central bank announced a cap on their currency in relation to the euro.  It has essentially pegged the franc to the euro.  On that day, the Swiss franc fell almost 10%.  That means that PRPFX would have lost 1% on that day alone, just from the Swiss franc portion of its holdings.

I still think that PRPFX is the best mutual fund you can buy for safety and growth.  If you can set up your own permanent portfolio, do it.  However, some people have limitations.  If you have a 401k, you may be able to get a brokerage link account that allows you to invest in mutual funds.  If you can do this, I would suggest you use it and put most of your money in PRPFX.  While I have my criticisms of the fund, it beats the alternatives in most cases.

2 comments:

John (Ad Orientem) said...

I concur with your endorsement of the Harry Browne PP. As for PRPFX, it is probably the best 2nd choice for those who either by choice or necessity are conservative investors and who don't want to deal with even the minimal effort required to set up and run an HB-PP. Still anyone considering PRPFX should be aware of its shortcomings.

1. It is an actively managed fund. These very rarely outperform their indexes over the long term.
2. The funds expense ratio is more than 3x what you would pay using index funds and ETFs in an HB-PP. Expenses matter.
3. The fund is weighted towards an inflationary scenario. Dollar assets (Bonds and Cash) are underrepresented. If you are going to go with PRPFX you may want to add some long term bond exposure. I would suggest putting 10% in EDV which is long term Treasuries on steroids. (Note: I don't recommend EDV for an HB-PP. I would stick with TLT for that.)

Like I said, PRPFX is an acceptable second choice for those seeking one stop shopping and radical diversification. But it has flaws and volatility is likely to be significantly higher. On the other hand, if we are (as I suspect) setting ourselves up for a nasty round of inflation then PRPFX may outperform the HB-PP in the near to intermediate term given its asset allocation.

That of course is prognosticating on future events, and pure speculation. :-)

LIBERTARIAN INVESTMENTS said...

Thanks for your comments. I agree with what you have said. I didn't address fund expenses in my post, but you are right that that is one more consideration and one more downside of PRPFX.