Andrew Hallam is the index investor for Globe Investor's Strategy Lab. Follow his contributions here and view his model portfolio here.
There are permanent portfolios and then there's the Permanent Portfolio.
Devised decades ago by the late investing writer Harry Browne, it combines gold, stocks, long-term bonds and cash in equal proportions. The mix never varies and the investor's only responsibility is to buy or sell once a year, as needed, to maintain the target allocation.
Sound too simple to work? Take a look at the results over the past few decades.
At the beginning of 1980, gold had just surged to an outlandish price (for the time) of nearly $850 (U.S.) an ounce. At the time, betting a quarter of a portfolio on the high flying metal would have looked crazy. Investing another 25 per cent of your money in U.S. stocks would have seemed like an equally dismal idea. The S&P 500, after all, was lower than it had been 15 years previously.
But someone who stuck to the Permanent Portfolio would have done just fine. Over the next decade, Mr. Browne's creation averaged 10.36-per-cent annual returns.
By 1990, stocks were enjoying an eight-year bull market – and the Permanent Portfolio looked sadly out of step with the new equity-happy era. With 75 per cent of its holdings in bonds, cash and gold, it seemed to be a quaint relic from a paranoid age.
But in the decade ahead, it averaged 7.7-per-cent gains, doubling in value with just one losing year (1994, when it lost all of 0.9 per cent).
Despite the results, few would have given the Permanent Portfolio serious consideration in January, 2000. Stocks had roared, cash offered paltry interest, and gold had lost 70 per cent of its value since 1980. But the following decade saw the portfolio average nearly 7-per-cent-a-year returns.
It followed with a 12-per-cent encore in 2010, 13.3 per cent in 2011 and 6.8 per cent in 2012. The portfolio suffered only two down years between 2000 and 2012, losing 0.7 per cent in 2001 and 2 per cent in 2008, when the S&P 500 dropped 38.5 per cent.
Why has such a simple investing idea done so well? It comes down to Mr. Browne's central insight: Nobody knows which asset class will do best over the year ahead. Owning a low-cost diversified blend of different assets and rebalancing annually ensures that an investor will always have a piece of what is going up, without any expensive guesswork.
Detailed thoroughly in The Permanent Portfolio by Craig Rowland and J.M. Lawson, the strategy is designed to produce safe returns in a variety of market environments: prosperity, deflation, recession and inflation.
If this sounds appealing, creating a Permanent Portfolio with Canadian or global equity exposure has never been easier. You could put 25 per cent of your money in Vanguard's FTSE Canada Index ETF (VCE), charging just 0.09 per cent. Or you could diversify globally, buying Vanguard's Total World Stock ETF (VT), costing 0.19 per cent.
For exposure to long-term government bonds, you could invest 25 per cent of the portfolio in BMO's Long Federal Bond ETF (ZFL), charging 0.2 per cent. Then follow it up with 25 per cent in a money market fund or short-term government bonds. Vanguard's Canadian Short-Term Bond Index ETF (VSB), charging 0.15 per cent, is the cheapest index option.
The remaining 25 per cent could go into the iShares Gold Bullion Fund (CGL).
What sort of returns can you expect? Between 1972 and 2012, the Permanent Portfolio averaged 9.43 per cent annual returns (in U.S. dollars) with just four losing years. No annual loss exceeded 4.9 per cent.
To be sure, bonds look overpriced these days, gold has dropped 20 per cent since January, cash returns nothing and global stocks (as always) face a tenuous future.
I think you could do better with a diversified portfolio of stock and bond indexes. But my pessimism has a familiar ring. As I've demonstrated above, things never look good for the Permanent Portfolio. It just seems to work.
Andrew Hallam