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Imagining the Worst

Adam M. Grossman  |  December 1, 2019

IF THE NAME Harry Browne doesn’t ring any bells, I’m not entirely surprised. Though he was twice a presidential candidate, he never captured more than 1% of the vote. Still, to my knowledge, Browne is the only financial advisor ever to run for the White House. 

As a Libertarian, some of Browne’s economic proposals were extreme—including, for instance, abolishing income taxes. But one of his ideas has stood the test of time: In his 1981 book, Inflation-Proofing Your Investments, Browne introduced the concept of the “permanent portfolio.”

Browne’s permanent portfolio was designed to make an investment mix “bulletproof,” able to withstand these four extreme events:

  • Hyperinflation, like that experienced by Germany after the First World War.
  • Deflation, along the lines of what Japan has suffered over the past 15 years.
  • Confiscation of assets, as seen in Venezuela, for example.
  • Devastation, including war and natural disasters.

How would the permanent portfolio simultaneously protect against all four of these extreme possibilities? Browne’s approach was to identify at least one asset that would survive each calamity. When there’s deflation, for example, cash turns out to be a great investment. When there’s inflation, stocks do well.

Using this logic, Browne was able to construct a portfolio that wasn’t necessarily immune to losses, but would at least be more immune than other approaches. Thus was born the permanent portfolio, which was comprised of four asset classes, held in equal amounts: stocks, long-term government bonds, gold and cash.

How has the permanent portfolio done over time? It depends how you look at it. From a performance perspective, it has lagged. Since 2001, the permanent portfolio has grown by a cumulative 170%, while the U.S. stock market has returned 278%. But that ignores risk, which was Browne’s primary concern. On that score, the permanent portfolio was a star performer exactly when investors needed it most. In 2008, when the U.S. stock market lost 37%, the permanent portfolio gave up less than 1%.

Others have followed in Browne’s footsteps. Notably, hedge fund manager Ray Dalio has popularized what he calls an all-weather portfolio, which is a near carbon copy of Browne’s portfolio. In fact, the concept predates Browne himself. Two thousand years ago, the Babylonian Talmud included this exhortation: “Let every man divide his money into three parts, and invest a third in land, a third in business and a third in reserve.” Similar ideas can be found in the writings of King Solomon, Shakespeare and others.

Is this the best way to invest? With the stock market again at all-time highs, it’s a question that many people are asking. As always, the answer is, “It depends.” There’s no such thing as the perfect portfolio—one that delivers strong returns with no risk. Everything involves tradeoffs. And in any case, I don’t believe in a one-size-fits-all approach. We’re all different. To help choose the approach that’s best for you, I suggest asking five questions:

1. How much risk can you afford to take? This was Browne’s primary concern. If you’re retired and need money from your portfolio to pay the bills, you can’t afford to lose all of your savings—but you may be able to afford to lose some. This is a simple mathematical question, and the answer will tell you how much you can afford to put at risk.

2. How much risk do you need to take? If you’re early in your career, you’ll want to invest in stocks to help your savings grow. But if you’ve already saved enough for retirement and your other goals, then you don’t need to take any risk. You may still choose to, but it’s important to recognize when risk is optional and when it’s required.

3. How much risk are you willing to take? How much do the regular ups and downs of the market affect you? How much do you worry about the sorts of extreme risks that kept Harry Browne up at night?

4. How much do you care about keeping up with the market? On any given day, how often do you hear references to the Dow or the S&P 500? These numbers are printed and recited innumerable times in the media every day, so it’s natural to compare your results to these benchmarks.

But here’s where it gets tricky. The more you diversify, the more your results will differ from these commonly cited indexes, and that carries a psychic cost. Sometimes, you’ll do better than the Dow or the S&P and sometimes worse. But however you fare, you can’t do an apples-to-apples comparison with these major indexes, because you can’t quantify the peace of mind that comes with greater diversification.

5. How important is it to accumulate the absolute maximum number of dollars? If your primary goal is to grow your investments, that’s a very different objective from Harry Browne’s. It’s an entirely valid objective—but it’s going to involve a very different portfolio and will likely involve a far bumpier ride.

Adam M. Grossman’s previous articles include The Unwanted PaydayNo Comparison and A Graceful Exit. Adam is the founder of Mayport Wealth Management, a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter @AdamMGrossman.

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