It can be a challenge for both new and experienced investors to decide how to build an investment portfolio that optimizes growth while minimizing risk. When building a long-term portfolio, diversifying between various assets is a key strategy. But, what is the best diversification method? There are so many types of assets to choose from, from stocks and bonds to real estate and buying and selling cryptocurrency.
Every investor wants to build an investment portfolio that comes with high returns and low volatility, but that’s easier said than done.
One strategy for simple asset allocation is called the permanent portfolio, which was introduced by investment advisor Harry Browne in his 1981 book, “Inflation-Proofing Your Investments.” The goal of the permanent portfolio is for it to perform well during both economic booms and recessions. It aims to provide both growth and low volatility. Historically the strategy has been successful.
Let’s dive into the details of the permanent portfolio, how to build one, and the pros and cons of the strategy.
What Is the Permanent Portfolio?
The permanent portfolio is diversified equally with precious metals, Treasury bills, government bonds, and growth stocks. The allocation is as follows:
• 25% U.S. Stocks
• 25% Treasury Bills
• 25% Long-Term Treasury Bonds
• 25% Gold
Although these investments can be volatile and incur losses, their values are not strongly correlated, so by holding some of each, investors may be able to prevent significant losses. The idea is that at least one asset in the portfolio is always working. Each asset class performs well in different conditions:
• Stocks tend to perform well during times of economic prosperity and are good for growth.
• Gold tends to protect from currency devaluations, perform well during inflation, and do fine during growth periods.
• Bonds are a safe investment that perform well during deflationary times and do fine during growth periods.
• Cash protects from losses during recessions and deflationary times, and is liquid.
Gold and bonds are generally safe havens during recessions and inflationary times, while the stock market provides growth during economic booms. Cash is stable and creates a source of funding for rebalancing and downturns.
Another way of looking at it is by categorizing the four asset classes into four economic conditions:
• Prosperity: Stocks perform well during prosperous times, as public sentiment is positively correlated to stock market increases.
• Inflation: Gold performs well during inflationary times because the purchasing power of the dollar decreases, so people flock to gold as a safe haven.
• Deflation: When the price of goods and services decreases, deflation occurs. Long-term bonds perform well in this environment because interest rates decrease, which increases the value of older bonds.
• Recession: Cash is good to hold during a recession while other assets are at a low. Investors can buy up assets while they’re down and still have some money on hand if they need it.
Rather than trying to predict the market and moving funds around accordingly, the permanent portfolio is a simple set-it-and-forget-it strategy for long-term investing.
Historical Performance
The permanent portfolio has historically performed as it’s designed to. It grows steadily over time and doesn’t experience significant losses during downturns. For example, during the 1987 market crash, utilizing the permanent portfolio would have only incurred losses of 4.5%, while a 60/40 portfolio would have dropped 13.4%.
In general, the permanent portfolio has a somewhat lower return than a 60/40 portfolio, but it carries less risk and volatility.
The permanent portfolio had an average annual return of 8.69% between 1978 and 2017, while the 60/40 portfolio earned 10.26%, and the 100% U.S. stock portfolio earned 11.50%. Within that time frame, the permanent portfolio outperformed the other two several times within five-year periods.
Pros of the Permanent Portfolio
There are several upsides to building a permanent portfolio:
• Simple, set-it-and-forget-it strategy. Once it’s set up, investors only need to rebalance it about once a year.
• Avoiding significant losses through diversification while gaining returns over time. The portfolio is designed to minimize volatility but still increase in value over the long term.
• Although assets such as stocks can grow significantly, they can also have significant downturns. The permanent portfolio grows more slowly over time while avoiding those losses.
Cons of the Permanent Portfolio
Like any investment strategy, the permanent portfolio does come with some downsides:
• Stocks tend to grow more over time than the other assets included in the portfolio, so investors miss out on some of that growth by only having a 25% stock allocation.
• The permanent portfolio includes only U.S. stocks, so investors miss out on exposure to emerging markets and international stocks. When Browne developed the permanent portfolio, international stocks were not a popular investment, so he would not have included them in his allocation.
• Another potential con is that the permanent portfolio only includes Treasury bonds. Other types of bonds can also be good choices for diversification.
• Although cash is a fairly safe asset to hold during a depression, that type of downturn doesn’t happen often. By holding such a large amount of cash, investors miss out on growth opportunities.
• Overall, the permanent portfolio is fairly conservative, so investors could see higher returns using another strategy. Allocating more to stocks and alternative investments is likely to provide greater growth.
Building a Permanent Portfolio
Although the permanent portfolio strategy outlines the percentage of funds to allocate to different asset classes, investors still need to select specific assets to invest in. For example, investors might choose individual stocks for their portfolio, or they might invest in ETFs that include solely U.S. stocks or bonds. The upside of ETFs is they are easy to buy and sell, they minimize fees, and they provide diversification.
Managing a permanent portfolio is fairly simple once it’s set up. It’s a good idea to rebalance the portfolio at least once a year to ensure that the 25% allocations remain the same. If one area of the portfolio has grown or declined, investors can rebalance to even them out.
The Variable Portfolio
Some investors may decide that the permanent portfolio is too safe for them and they’d prefer a strategy conducive to higher growth. Using the variable portfolio method, investors put 5% to 10% of their money into riskier or more experimental investments. That way, the majority of holdings are still in the steady growth permanent portfolio, but investors can play around with some alternative investments as well.
Alternatives to the Permanent Portfolio
Although the permanent portfolio has its merits and has historically performed well, it isn’t the best choice for everyone. Some investors might want to allocate more of their portfolio to stocks, while others might want to diversify into more types of assets. There are many investing strategies out there to choose from, or investors can create their own.
Just because a particular strategy has performed well in the past doesn’t mean it will continue to do so in the future. It’s important for investors to do their own research and due diligence to decide what works best for their own goals and risk tolerance.
Below are some of the most popular strategies:
60/40
The 60/40 strategy is popular, especially among retirees, because it has performed very well over the past century.
It involves creating a portfolio with 60% stocks and 40% bonds. Similar to the permanent portfolio, the 60/40 gives investors exposure to the growth of the stock market while reducing risk and volatility with the inclusion of bonds.
The benefit of the 60/40 strategy compared to the permanent portfolio is that it has a large stock allocation, but some still consider the 40% bond allocation too high. There has also been discussion in recent years about whether the 60/40 portfolio will continue to be a successful strategy in the coming decades.
Business Cycle Investing
Those looking for an intermediate-term strategy might want to use the business cycle investing strategy for some or all of their portfolio. Using this strategy, investors keep track of the business cycle and adjust their investments according to which stage of the cycle the nation is in. Different industries and types of assets do better within each stage of the cycle, so investors can make predictions about when to buy and sell each asset and invest accordingly. To execute this strategy effectively, it is a good idea to have an understanding of past market contractions and their catalysts. This strategy requires more time, research, and effort than long-term, set-it-and-forget-it strategies, but can be successful for those willing to put in the work.
Rule of 110
Investors subtract their age from 110 to figure out what percentage of their money to allocate to stocks and bonds. For example, a 40-year-old would create a portfolio of 70% stocks and 30% bonds. As the investor gets older, they rebalance their portfolio accordingly.
Dollar-Cost Averaging
Here, investors put the same amount of money toward any particular asset at different points in time. Rather than putting all of their money into the markets at once, they space it out over time. Utilizing the dollar-cost averaging strategy allows investors to average out the amount they pay for that asset over time. Sometimes they buy low and sometimes they buy high, but they aren’t attempting to time the market or predict what will happen.
Lump Sum Investing
With the most basic strategy of all, investors put all of their available cash into the stock market right away. There’s no waiting for a particular time or trying to figure out what else to invest in. The theory behind this is that the overall trend line of the stock market continues to go up over the long term, even if it has downturns along the way. This might be a choice for investors who simply want to take advantage of stock market growth and aren’t afraid of volatility.
Alternative Investments
In addition to stocks and bonds, investors may want to consider diversifying into alternative investments, which could include real estate, franchises, cryptocurrencies, or farmland. While some alternative investments carry a lot of risk and require research, they can also come with significant growth.
A Platform to Invest In
Now you know a bit more about the permanent portfolio strategy as well as some options. Once you’ve decided what your investing strategy is going to be and created some personal financial goals, you’re ready to start building your portfolio.
One easy way to build out an investment portfolio is using an online investing platform like SoFi Invest®. Using the platform, an investor can research stocks, ETFs, and other assets, and keep track of favorites as the market changes. Invest in traditional assets like stocks, and even alternatives such as cryptocurrencies.
SoFi Invest offers both active and automated investing right from a phone. Investors can pick and choose each individual stock they want to buy. Those who prefer to have someone else do the research can choose from pre-selected groups of ETFs and stocks.
The platform also has tools for keeping track of personal budgets and goals, and looking at all investment accounts in one simple dashboard.
SoFi Invest®
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Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
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