Revisiting the “Permanent Portfolio”

What if you didn’t need to worry about the timing of a crash, or indeed any economic scenario, and could assemble an investment mix that would withstand whatever economic conditions might affect your portfolio?

It’s not a new idea. In 1970, my old friend Harry Browne, who died in 2006, came up with a concept called the “Permanent Portfolio.” It hasn’t gotten nearly the attention it should have, but its long-term performance is impressive: an 8.5% average return in the 53 years since Browne conceived it.

Just as importantly, this strategy would have largely preserved the purchasing power of your assets in an era when the real inflation rate is significantly higher than the official Consumer Price Index. What’s more, even during the period from 2008-2021, when the Federal Reserve kept interest rates at or near zero, this strategy gained an average of 7% annually.

Harry Browne’s Permanent Portfolio investment strategy is based on the economic cycle, which has four primary components:

1. Prosperity

2. Inflation

3. Deflation

4. Recession

Four asset classes provide a way to profit during each of these four economic states, without needing to forecast or predict their timing or duration. Each element hedges against the others, historically providing a positive rate of return, no matter what the economy throws at you.

1. Stocks. They provide strong returns during periods of prosperity and declining inflation but perform poorly during recessions and when interest rates are rising.

2. Bonds. They do well during periods of declining interest rates and deflation but perform poorly during inflation.

3. Cash. In a recession, no asset class is likely to do well. Cash is a hedge during deflation and when other parts of the portfolio fall in value.

4. Gold. This provides protection in periods of inflation, especially hyperinflation. Gold also hedges against market instability and a falling currency.

Equal allocations (25% each) of these four asset classes comprise the Permanent Portfolio. At the end of each year, tally up the value of each portion of the Permanent Portfolio and rebalance it to re-establish a 25% position in each asset class.

It’s that simple: you only need to few transactions annually to maintain the value of your wealth from inflation, deflation, and recession.

You can follow Browne’s asset allocation model today by purchasing a no-load S&P 500 Index fund, American Eagle gold coins, and Treasury bills and bonds from Treasury Direct. However, a more convenient way to buy these assets is to purchase a combination of exchange-traded funds (ETFs) designed to mimic each component of the Permanent Portfolio.

Admittedly, this strategy had a terrible year in 2022, falling in value by 11.6%. It’s the worst performance by far in the history of this strategy and the only double-digit loss. Still, the Permanent Portfolio far outperformed the S&P 500 (down 17.8%) or long-term Treasury bonds (down a stunning 29.6%). It also clobbered a 60% / 40% mix of stocks and bonds (down 22.5%).

It’s also worth noting that over the decades, the performance of the Permanent Portfolio has gradually declined. While it’s experienced only eight losing years out of 53, with the largest loss ever in 2022, four of those losing years occurred in the most recent decade.

Here’s the decade-by-decade historical performance:

• Average annual return 1970-1979: 13.0%

• Average annual return 1980-1989: 11.0%

• Average annual return 1990-1999: 6.6%

• Average annual return 2000-2009: 6.8%

• Average annual return 2010-2019: 6.8%.

• Average annual return 2013-2022: 6.4%

Thus, while the long-term (50-year) average return of the Permanent Portfolio is nearly 9%, going forward, 7% or slightly less might be more realistic.

While 7% is still an exceptionally good risk-weighted return, it pales in comparison to a long-term portfolio of stocks, which since 1872 has generated a compound annual growth rate (CAGR) of 9.1% annually. This is a powerful argument for simply buying index funds that passively follow a market index; typically, the S&P 500.

That’s the approach Warren Buffett, the most successful investor in history recommends for most investors. He believes long-term ownership of stocks is the closest thing there is to a guaranteed winning investment strategy in the financial markets.

While it’s hard to disagree with his overall premise, a portfolio composed exclusively of stocks is far more volatile than the Permanent Portfolio. For instance, if your grandparents had purchased a stock portfolio corresponding to the S&P 500 in August 1929 (just before the stock market meltdown that resulted in an 86% loss in this index),they wouldn’t have broken even October 1954.

Adjusted for inflation, they wouldn’t have broken even until December 1958. Three decades is a long time to wait for your portfolio to recover!

Another critique of the Permanent Portfolio concept is that gold is the only one of the four investment classes not denominated in dollars. If the dollar were to collapse in value, wouldn’t the value of the Permanent Portfolio collapse as well?

Not necessarily. In a dollar collapse scenario, it’s likely the gold component would go a long way toward balancing out losses in the other three portfolio components. What’s more, in a hyperinflationary economy, investors will often purchase stocks as a way to shield themselves from price increases in goods and services. Interest rates will rise as well, increasing the performance of the cash share of the portfolio.

Indeed, we simply don’t know of a lower-risk long-term investment approach. When we consult with clients, we sometimes tell them to split their wealth into two imaginary piles:

1. Wealth they can afford to lose.

2. Wealth they can’t afford to lose.

For wealth you can afford to lose, feel free to invest it in whatever asset class which you feel gives you the best return commensurate with the risks you’re willing to take. But for wealth you can’t afford to lose, the best solution we’ve found is the Permanent Portfolio.