Should We Rethink the Permanent Portfolio?

I am a strong advocate of investing a majority of your money in something similar to the permanent portfolio as described by Harry Browne in his book Fail-Safe Investing (also see Kindle version).  It is set up to withstand any kind of economic environment and to avoid the need to speculate.

After the FOMC's statement on June 19, 2013 and Bernanke's press conference, investment markets turned sour.  The stock market plunged, the bond market plunged, and the gold price plunged.  In other words, even if you were invested in the permanent portfolio, you took significant losses in the couple of days that followed.  75% of your investments took a hit, while the cash portion stays almost the same due to low interest rates.

While the permanent portfolio has not been a great performer as of late, I also don't think it is time to abandon the strategy.  There are going to be days when all of the asset classes (except the cash portion) are highly correlated and some of those days will be on the down side.  There will even be short periods of time when they all do poorly.

Stock market investors who advocate a buy and hold strategy often say that we should be in it for the long term.  But the long term in the stock market could be decades.  If you had bought an index fund in the Japanese stock market 25 years ago, you would still be down.  While this example may seem unfair, it illustrates the power of the permanent portfolio in that it rarely has a negative return for longer than a year.

It is important to realize that there will be periods of losses, but these periods should not last a long period of time.  Harry Browne recognized this.  To quote his book, he said the following:

"Tight money is usually characterized by rising interest rates, which are bad for most investments.  The only attractive investment during a recession is cash.  And your cash holdings may not completely offset the losses that tight money may inflict on the rest of your portfolio.

"But tight money is by nature a temporary condition.  Unlike prosperity, inflation, or depression, it can't go on indefinitely.  Either the economy adjusts to the new level of money and returns to prosperity, or the supply of money changes - leading to inflation or a full-scale deflation."

He understood free market economics.  He understood that if there was a recession due to a tight monetary policy (or I suppose an expected tight monetary policy), then things would readjust and prosperity would eventually return, unless the central bank kept interfering.  Either way, you end up with prosperity, inflation, or a deflationary depression.  A recession cannot go on forever without turning into one of those other things, which are all covered in the portfolio.

So while I actually think that interest rates are likely to go back down in the near term, we don't need to lose sleep over the possibility of continually rising interest rates.  This means we will either get higher inflation (and higher gold prices) or we will get a recession to clear out much of the malinvestment.

I'm guessing even Harry Browne could not have imagined that the Fed would be creating new money at a pace of $1 trillion per year.  But he did understand the various threats to your portfolio and developed something to help people avoid significant losses.  While the permanent portfolio is far from perfect, I am still waiting on someone to come up with something better.