Permanent Portfolio - The Ultimate Guide

Creating the Permanent Portfolio: The Ultimate Guide

Maintaining a diversified investment portfolio is a long-term strategy that has many advantages, especially when it comes to reducing risk and building wealth over time. You can take several different approaches to build your own investment portfolio through a diverse number of asset classes, but investing in the right combination of assets, and in the right proportions, can just as easily lead to failure as it can lead to success.

Investment analysts have spent much time and energy devising different approaches to portfolio building in an effort to discover as ideal a ratio of assets as possible. One such approach, known as the Permanent Portfolio, has been a perennial favorite among investors since its inception four decades ago. Here's more information on the Permanent Portfolio, the key concepts behind it and how to begin setting up your own investments to follow this strategy.

What is a Permanent Portfolio?

First conceptualized in the 1980s by investment analyst Harry Browne, the Permanent Portfolio is an investment portfolio that was specifically designed to weather differing economic conditions over time and still perform well. 

The typical Permanent Portfolio contains an equal split between several asset classes, including stocks, bonds, gold and cash or Treasury bills.

The Objectives of the Permanent Portfolio 

The Permanent Portfolio, as originally designed, was created as a vehicle for ensuring the overall growth of long-term investments, especially when market conditions change significantly throughout that time. Browne chose his design carefully to provide safe, low-risk but profitable performance by using a modified version of efficient market indexing. In this way, Browne ensured that investors would be able to achieve both safety and growth when balancing their asset classes accordingly, despite market or economic conditions.

Since no specific asset class performs well in all economic environments, the Permanent Portfolio works by diversifying an investor's holdings so that when one type of investment underperforms as a result of market conditions, one or more other asset classes make up for the difference. This safeguards investors against loss when the asset classes held in their portfolio are balanced carefully and thoughtfully to hedge against any foreseeable eventuality.

Advantages of a Permanent Portfolio

Permanent Portfolios have several advantages for investors, including:

• Simplicity: Setting up a Permanent Portfolio is a one-time event that doesn't need constant monitoring. Rebalancing it annually is usually the only maintenance needed for this type of investment strategy.

• Good risk management: The diversification inherent to the Permanent Portfolio is an excellent risk-management strategy, as investors can avoid significant losses through that diversification. The portfolio is designed to minimize volatility but still provide long-term returns in value.

• Downturn avoidance: The Permanent Portfolio is specifically positioned for long-term growth. This largely insulates investors from any downturns that assets like stocks can suffer in the shorter term. The slow growth of the portfolio avoids losses related to downturns.

Disadvantages of a Permanent Portfolio 

Still, while there are many benefits to using a Permanent Portfolio, the practice isn't without its drawbacks. The disadvantages of a Permanent Portfolio include:

• Low room for stock allocation: Stocks tend to exhibit more growth over time than other Permanent Portfolio assets. Yet at only 25% of your asset allocation, the growth of the stocks in your portfolio is effectively limited.

• No space for emerging markets: Permanent Portfolios only include U.S. stocks, which means that international stocks and other emerging markets aren't part of the equation. This limitation is because Browne designed the approach at a time when international stocks were an unpopular investment.

• Holding cash limits growth: Cash is a reliable asset to hold during recessions, but such downturns aren't necessarily numerous. Holding large amounts of cash can limit growth opportunities from other asset classes. Further, cash can generate negative yields during periods of high inflation.

Building Your Own Permanent Portfolio 

You can create a Permanent Portfolio in a few different ways because there are so many investment opportunities available to the average trader. The following example showcases one way an investor could configure their portfolio:

• 25% in U.S. stocks provides for a positive rate of return in strong economic conditions. A basic S&P 500 index fund was Browne's recommendation at the time he designed the Permanent Portfolio.

• 25% in long-term U.S. Treasury bonds also performs well in strong economic conditions. They also do well when deflation occurs. But the advantages of this asset class are less prevalent in different economic cycles.

• 25% in cash hedges against recessions and poor economic climates. In this context, cash is best held in short-term U.S. Treasury bills as opposed to longer-term bonds.

• 25% in gold or another precious metal is an excellent way to protect against inflationary periods. While Browne recommended gold bullion coins, a modern investor might be better suited in investing in exchange-traded funds (ETFs) that focus on gold bars or bullion.

Understanding the basic theories of how the Permanent Portfolio works is a necessary step if you want to build your own version of this investment strategy. The information we've shared above is a great starting point, but you should delve even deeper into the details of how the Permanent Portfolio works and different methods for adapting its rules and principles for your own investing activity.

In practical matters, building your Permanent Portfolio requires access to a trading platform, especially if you plan to manage the portfolio yourself. As the Permanent Portfolio is a fire-and-forget investment style that's best suited to only occasional maintenance over long periods of time, this type of investment activity is often considered more accessible and beginner-friendly than others. Yet even a relatively straightforward approach to investing can be overwhelming for the inexperienced, which is another reason that partnering with a trading platform is a positive step in the right direction.

An ideal trading platform is one that offers robust customer service, has an intuitive user interface, is affordable when it comes to its service fees and provides you access to the markets you wish to trade. Additional resources, such as data visualization or managed brokerage services, can also help differentiate a good trading platform from a great one. Finally, closely watching the financial markets and learning as much as you can about the different asset classes you are interested in investing in is perhaps the most important aspect of building a good Permanent Portfolio.

The Permanent Portfolio is an investment strategy specifically designed to provide low-risk, long-term growth through carefully balancing diversified asset classes. The four core asset classes are chosen deliberately to ensure overall growth despite economic conditions. While this has been an effective strategy in the 40 years or so since its inception, the Permanent Portfolio has some limitations. The most notable of these include the potential to miss out on better growth through equities because of how relatively conservative the strategy is.

Despite this drawback, the stability and long-term return on the Permanent Portfolio make it an excellent core holding. Many investors choose to maintain a Permanent Portfolio and then separately invest other resources in higher-risk, short-term investments that offer a potentially higher reward, knowing they can always fall back on the returns their Permanent Portfolio provides.