The permanent portfolio strategy aims to provide both growth and low volatility to investors, performing well during times of economic growth as well as recession.
Given the current volatility in the markets, investors are uncertain about the financial markets and what investment strategy they should adopt now. However, instead of panicking it is important for investors to take this opportunity to re-evaluate their current long-term investment strategy to find ways and means to improve their portfolio performance. It is a challenge for not only new investors but also for experienced investors to decide on how to go about building an investment portfolio which will optimise growth and at the same time minimise risk.
When building a long-term portfolio, diversification among various asset classes is a key factor. But what is the best diversification method? Let us find out the answer for the same through a permanent portfolio investment strategy.
Mechanics of permanent portfolio strategy
The concept of permanent portfolio was introduced by free-market investment analyst Harry Browne. The goal of the permanent portfolio is for it to perform well during times of both economic growth and recessions. It aims to provide both growth and low volatility and empirical evidence states that this strategy has been successful.
Some asset classes will do well, and others will do poorly. Instead of attempting to predict which asset classes will outperform, it holds four negatively correlated basic asset types, which counter-balance each other. On the whole, the portfolio grows as well as, and at times even better than, the total stock market, without huge swings in volatility, which are difficult to handle.
Zero forecasting is required
No one can predict what will happen in the future. Promises to predict the future in investing are endemic and probably result in large losses and poor investment decisions. Under permanent portfolio asset allocation strategy no prediction is required; rather it recognises the fact that the situation in financial markets will always change.
Largely eliminates loss
Investors across the globe hate to lose and they hate even the potential or perception of loss. The phenomenon is known as ‘loss aversion’ and it is the reason why investors end up buying high and selling low instead of the reverse.
Under this strategy, investors create a portfolio of four negatively correlated basic asset types such as equity, bond, gold, and cash. People enthusiastically acquire these four major asset classes when times are good or flee to them when things get scary. When business is good, everyone is enthusiastic about stocks. When inflation, deflation, or recession are looming, investors flee from stocks into bonds, gold and treasury bills. By owning all four asset classes, returns are stable, irrespective of the whims of the market. Gold and bonds are considered as safe havens during recessions and inflationary times, while the stock market provides growth during economic booms. Cash (Treasury bills) is stable and a source of funds for rebalancing and downturns in the economy.
To conclude, this strategy takes care of all situations like prosperity, inflation, deflation, and recession. Rather than trying to predict the market and moving funds around accordingly, this is a simple set-it-and-forget-it strategy for long-term investing. Managing a permanent portfolio is fairly simple once it’s set up. It is advisable to rebalance the portfolio at least oncea year to ensure that the individual allocations remain at the pre-allocated 25% levels.
The writer is a professor of finance & accounting, IIM Tiruchirappalli.
