We have arrived at mid-year 2010 and can now take a look at the half-year results of the lazy portfolios we have been tracking. It looks like the Paul Boyer Permanent Portfolio has gained 1% per month this year. Just four of the portfolios are positive with three of them based around the Permanent Portfolio concept. Portfolios P2 and P1 used Vanguard mutual funds. If we would have used the recommended ETFs TLT, SHY, VTI, VBR, VWO, and GLD, the results were 6.6% and 6.1%, respectively.

Have you shifted into a Permanent Portfolio yet?

Here are the returns of the individual components of the lazy portfolios:

*Note that these results use Yahoo! Finance adjusted historical returns with the exception of IFA portfolios results from IFA.com that include IFA’s fee.

Dave sent this to me and said I could post it for all of you. Nice analysis of how the Permanent Portfolio did last month.

Permanent Portfolio performance during the very volatile month of May

This May was the worst May since 1940.  The Dow and VTI (total stock market) both had losses of -7.9%.  Volatility has returned to the market!  When the market is volatile, the wisdom of investing in the Permanent Portfolio becomes apparent.  The Harry Browne Permanent Portfolio always has the same four assets: total stock market (VTI), gold (GLD), long term Treasury bonds (TLT) and short term Treasury bonds (SHY).  These assets are rebalanced each year.

Let’s see how the Permanent Portfolios performed on a weekly basis for the very volatile month of May.

Date                Stocks            Gold           Long Bonds     Short Bonds      PermPort
—               VTI               GLD                 TLT                  SHY

May   3 –   7          -7.0%               2.5%              4.1%                  0.3%                     0.0%
May 10 – 14           3.0%               1.8%             -0.7%                  0.1%                     1.0%
May 17 – 21          -4.5%              -4.3%              3.7%                 0.1%                    -1.2%
May 24 – 28           0.7%               3.2%             -2.0%                  0.0%                     0.5%

Total for May       -7.9%               3.1%              5.1%                  0.5%                     0.2%

2010 to May          -0.1%             10.8%              8.9%                  1.4%                     5.5%

The week-by-week returns show that the Permanent Portfolio is much less volatile than the VTI.  The volatility is amazingly low because the VTI and TLT (and GLD) move in opposite directions — they are negatively correlated.  The first week of May provides a good example of the negative correlation of the assets:  the VTI was down -7.0% while GLD was up 2.5%, TLT was up 4.1% and SHY was up 0.3%.  This resulted in a 0.0% change for the Permanent Portfolio.  The returns for each of the other three weeks further demonstrate the negative correlations of the assets.

The final returns for the month of May show that if you had been invested in the Permanent Portfolio you would have been ahead by 0.2% instead of being behind by -7.9% for a VTI investment.  A Permanent Portfolio investor would not think that this May was the worst May since 1940.

The last line in the table shows the year-to-date returns for each of the assets.  The advantage of the Permanent Portfolios over the VTI (total stock market) is obvious.

The main problem with the Permanent Portfolio is that it is just too boring for most investors!

Here are the Year-To-Date returns of the Lazy Portfolios through the end of May 2010. The components of each portfolio are listed at the end. The “Paul Boyer Permanent Portfolio” is my modification of the Harry Browne Permanent Portfolio where instead of investing 25% in the total US stock market, we invest 12.5% in US Small Cap Value and 12.5% in Emerging Markets.

Below is a Return vs. Risk Chart for these portfolios from 1985 through 2009 (Note: this chart does not include returns through the end of May 2010). The ideal portfolio would be high return at low risk and thus appear at the top left of the chart. [Chart data is computed using Simba's spreadsheet from the Bogleheads.org forum with the exception of IFA portfolios from ifa.com.]

See how there is almost an invisible boundary line from lower left to upper right? That is the “Efficient Frontier” and shows that returns are correlated with risk over the long term. It is nearly impossible to construct a portfolio that will be above that efficient frontier. So the only question you need to answer is, how much risk are you willing to accept. That is, can you tolerate the downturns in the market in the short term?

Looking at a shorter term, here is a chart showing just the previous ten years from 2000 through 2009.

I like the boost to returns the Paul Boyer Permanent Portfolio got during prosperity and it didn’t hurt too much during recession either.

And to see if you can indeed stomach a bad short term, here is a chart with just the previous three years:

How about a chart of just the recent heyday of stocks from 2003 thru 2006:

Looking at past charts is fun, but should not be the only data you use to make investment decisions. I like the Permanent Portfolio concept because it is so simple, has low fees, and covers the four economic cycles of prosperity, inflation, deflation, and recession. It has been shown to be the lowest in risk among the lazy portfolios while not sacrificing returns. They are the only portfolios to include gold.

Here are the components of each of the portfolios*:

*Note that these results use Yahoo! Finance adjusted historical returns with the exception of IFA portfolios results from IFA.com that include IFA’s fee.

In his MarketWatch article today, Mark Hulbert writes,

Would you be interested in an all-weather portfolio that, despite hardly ever changing its composition, performs creditably in almost all market environments?

Hulbert characterizes the Permanent Portfolio this way:

Browne’s idea was to invest in a basket of asset classes, each one of which has a low correlation with the others. As a result, when any one of the asset classes is performing poorly, there is a good chance that the others will at least be holding their own — if not actually appreciating in value.

He describes Harry Browne’s Permanent Portfolio as an antidote to volatility. He then gives some past performance of the PRPFX fund which somewhat implements Harry Browne’s concept:

This fund over the last 15 years (through Apr. 30) has produced an 8.2% annualized return, which is remarkable given that stocks, gold and bonds did not, individually, do as well: The Wilshire 5000 index gained 7.9% over the same period, the Shearson Lehman Treasury Index produced a 6.3% annualized return, and gold bullion rose at a 7.7% annualized pace.

I might suggest that while the result of the four asset classes is low correlation, that is not the way Harry Browne explained the reasoning. Instead, the portfolio is designed to have one component that does well in each of four different economic circumstances: prosperity (stocks), inflation (gold), deflation (LT Bonds), and recession (cash). Harry said that while you can expect one of the assets to go down, the one that goes up more than makes up for the loser. For example, while one asset may go down 30% or 40%, the winning asset can go up 200% or 300%, more than making up for the loss.

I think the best thing about the portfolio is this: No one can predict the future so we might as well invest in all possibilities.

So, how has the Harry Browne Permanent Portfolio done so far in 2010?

Thru yesterday’s market turmoil, the components have done the following:

VTI +2.8% (Stocks)

TLT +9.2% (Bonds)

SHY +1.3% (Cash)

GLD +10.4% (Gold)

And the total portfolio, assuming 25% in each at the start of 2010 is…

+5.9%

How’s that compare with YOUR portfolio?

If you have any questions about Harry Browne’s Permanent Portfolio, head over to the Permanent Portfolio Discussion Forum that CraigR just started over at CrawlingRoad.com. Experts there have studied it from all angles and can help you get it implemented yourself.

And here’s the book you need to read:

The latest video from MadMoneyMachine studios:

I put the video together for this audio interview with Vanguard Group founder John Bogle. I hope you like it.

Harry Browne’s Permanent Portfolio is so simple. Split your investments into equal parts stocks, bonds, cash, and gold. Is it too simple? Can it be improved yet remain simple? I used Simba’s spreadsheet (from Bogleheads.org) to back-test some alternatives from 1972 through 2009.

First, the original portfolio:

Stocks: VTSMX (Total US Stock Market)
Bonds: VUSTX (Long-term Bond)
Cash: VMPXX (Money Market)
Gold (Kitco 1972-2004, GLD 2004-2009)

yielded the following return vs. risk:

P1 (HBPP):

Compound Annual Growth Rate (CAGR): 9.1%
Standard Deviation (Risk): 8.02%
Sharpe Ratio: 0.46

Next, substitute 2-Year Short Term Treasuries (VFISX) instead of Money Market:

P2 (P1 with 2-yr T-Bills):

CAGR: 9.5%
Standard Deviation (Risk): 8.17%
Sharpe Ratio: 0.50

Alternatively, how about for the “Prosperity” component, i.e., Stocks, we substitute  half US Small-Cap Value and half Emerging Markets for the US Total Stock Market:

P3 (P1 with 12.5% VISVX and 12.5% VEIEX):

CAGR: 10.8%
Standard Deviation (Risk): 8.57%
Sharpe Ratio: 0.64

And finally, combine P2 and P3 to have 2-yr T-Bills, US Small Cap Value, and Emerging Market:

P4 (P2 with 12.5% VISVX and 12.5% VEIEX):

CAGR: 11.3%
Standard Deviation (Risk): 8.65%
Sharpe Ratio: 0.68

And just for comparison I ran “Solver” on Simba’s spreadsheet to find the least risky portfolio that yielded 11.3% of that time span. It came up with the following mix:

VISVX (US Small Cap Value): 13.43%
VEIEX (Emerging Market): 14.30%
PCRIX (Commodities): 5.19%
VFITX (5-Yr T-Bills): 49.31%
VFISX (2-Yr T-Bills): 7.88%
Gold: 9.88%

Which resulted in:

P5 (Solver optimized portfolio):

CAGR: 11.3%
Standard Deviation (Risk): 7.25%
Sharpe Ratio: 0.80

And here is a chart with them all plotted, CAGR vs. Standard Deviaion (Risk):

I’ve played with lots of combinations of back-tested portfolios through many different time periods and one thing is common: substituting VISVX and VEIEX for VTSMX resulted in higher returns and a higher Sharpe Ratio. And short term T-Bills for cash also added nicely.

Note that I only show the Solver optimized portfolio (P5) for reference. I believe it strays too far from the Permanent Portfolio strategy to be safe going forward.

I talked about P4 on MMM-175: The Perfect Portfolio. While I am not yet invested in it, it is the one I am targeting. I do not expect a CAGR of 11.3% for the next 37 years, but if I can get 6% I will be very happy.

It is truly surprising, amazing, astonishing to find out how poorly active managers do when compared to indexes. Watch this video:

Have a look at this video. It points out the importance of long-term data, the irrelevance of even reliable advice, the emphasis of trading by the financial media, and the wisdom of Nobel prize winners regarding investments.

Oh, and don’t miss THE END-ing!