Enhancing Your Permanent Portfolio

Yesterday, I wrote about the permanent portfolio and how you should still stick to this methodology of investing, despite its relatively poor performance of late.  In this post, I want to offer some possible tweaks that may enhance the portfolio and allow you to sleep even better at night, knowing your money is as safe as it can be.

I have made this suggestion in the past and I want to reiterate it now, especially with interest rates having gone up in the last few weeks.  You don't have to be a libertarian to invest in the permanent portfolio, but I find that most people who do subscribe to the advice tend to be libertarians.  I suppose it is because it was offered by Harry Browne, who himself was a great libertarian.  But beyond that, libertarians understand that monetary inflation is a major threat to their assets, so the 25% gold portion is appealing.  How many other portfolios will you find where the recommended gold holdings are at least 25%?

Right now, a lot of libertarians are scared about bonds.  There are certainly a lot of good reasons to be fearful of them.  There is a possibility of higher interest rates due to many factors, including inflation, the threat of default, and, as recently shown, the possibility of the Fed's tapering of its buying of government bonds.  With a huge national debt and the possibility of higher price inflation in the future, there are definitely reasons to be bearish on bonds.

But at the same time, we can't completely abandon bonds in the permanent portfolio.  They are there for a reason.  It is possible that Bernanke and company could decide tomorrow that it will stop all monetary inflation.  If that happens, we would likely see some kind of a recession/ depression, with the possibility of price deflation and lower interest rates.  While this is not highly likely, we really shouldn't speculate to the point where we leave ourselves vulnerable.  There are less extreme scenarios where we could still see falling rates and rising bond prices.

So I recommend that if you have a home mortgage, you should consider paying down the loan.  While you won't derive a huge benefit from falling interest rates as you would with owning bonds, you will still be locking in a rate of return that is equivalent to whatever the interest rate is on your home loan.  And you won't have to pay taxes on your hidden gain.

This is a deflation hedge because you are locking in a rate of return.  If your home loan has an interest rate of 4%, then you will be locking in the equivalent of a 4% return.  If rates fall to 2%, then at least you will be getting a better "return" from paying down your mortgage than you would have if you kept it in cash or a cash equivalent.

I don't recommend abandoning bonds entirely, no matter what you think is going to happen.  You still need some upside if a deflationary depression comes along.  Instead of having 25% in long-term bonds as the permanent portfolio calls for, you could have 12.5% in bonds and use the other 12.5% to pay down your mortgage.

This may not be a perfect strategy, but it is a way to diversify even a little bit more and you won't have to worry as much about rising rates.

If you own a home and don't have a mortgage, then you already have somewhat of a deflation hedge with that.  Because of that, you could lighten up the bond portion of your portfolio just a little bit.  Perhaps you could have just 15 to 20 percent in bonds instead.  This will depend on how much money you have and how much your house is worth.

If you rent and you don't have the money for a down payment to buy a house, then you probably don't have enough money to worry about the whole thing.  You should be concentrating more on saving money (earning more and cutting costs) than investing.

If you rent, yet have a decent net worth, then perhaps you should consider buying if you plan to stay in the area.  You could also consider buying an investment property, something that I advocate if you are in the right position to do so.  If your situation is such that you just can't buy a house right now or you simply don't want to, then it will probably be best to stick with something close to the 25% portion of bonds in your portfolio.