Permanent Portfolio: Building a Resilient Portfolio for the Long Term

Introduction

Have you ever considered this: a portfolio with average returns just 2-4% higher than a regular bank term deposit, but with losses highly unlikely to exceed at 10-15% even during the most of market crashes?

Ray Dalio’s All Weather Portfolio somewhat fits the bill, with an average return of 7.7% over the past 30 years. However, it did suffer a loss of -20.6% in 2022, which has somewhat tarnished its reputation. Is there a portfolio that may offer slightly lower returns than All Weather but with smaller potential losses? The Permanent Portfolio is a strong candidate. It's designed to provide consistent returns with minimal downside risk.

ETF Composition

Source: www.lazyportfolioetf.com

It’s composed of 25% stocks, 25% gold, 25% long-term bonds, and 25% ultra short-term bonds (cash equivalent). You could use an S&P 500 ETF for the stock portion, or VTI (Vanguard Total Market ETF), which covers all U.S.-listed stocks.

Historical Performance

Source: www.lazyportfolioetf.com

• Rebalancing on January 1st each year. Dividends are reinvested.
• Fees and capital gains taxes are assumed to be zero.
• Maximum period: January 1, 1871 – August 31, 2024

As of the end of August 2024, the Permanent Portfolio has achieved a solid return of 10.6% year-to-date and 15.9% over the past 12 months. However, when we extend the period to the past 10 years, the annual return drops significantly to 5.5%. Over the past 30 years, it was 6.6%.

In the table, you can also see the inflation-adjusted returns, which show positive returns across all periods. For comparison, the inflation-adjusted return of the All Weather Portfolio over the past 5 years was -0.1%. While the Permanent Portfolio’s return in this period wasn’t great at 1.4%, it still outperformed the All Weather Portfolio.

Maximum Drawdowns

Source: www.lazyportfolioetf.com

The chart above shows the maximum drawdowns of the Permanent Portfolio over the past 55 years, starting from 1970. The worst was in 2022, with a -15.9% drawdown. While not shown in the chart, it’s worth noting that over the 154 years since 1871, aside from the Great Depression's -30.6%, 2022’s -15.9% was the worst on record.

In 1974, during the Fourth Middle East War and the oil shock, the maximum drawdown was -11.2%. During the severe recession of 1982, when legendary Fed Chair Paul Volcker raised interest rates to around 20%, it was -11.7%. And in 2008, during the global financial crisis, often regarded as the worst crisis since the Great Depression, it was -12.6%. Considering these, I would rate the Permanent Portfolio’s resilience quite highly.

Backgrounds

Creator: Harry Browne (1933–2006). He was an American author, investment advisor, and politician, and he ran as the Libertarian Party's presidential candidate in the 1996 and 2000 elections. Although the U.S. is primarily a two-party system, the Libertarian Party is still the third-largest party. Browne wrote 12 books, selling over 2 million copies in total, making him a successful author. In his book, “Fail-Safe Investing: Lifelong Financial Security in 30 Minutes," he provided a detailed explanation of the Permanent Portfolio.

Logic: The portfolio aims to perform well under all economic conditions through a balanced asset allocation, which may sound similar to the All Weather Portfolio - this is why I often compare these two portfolios. To achieve that, assets are equally allocated with 25% each to stocks, bonds, gold, and cash. In practice, ultra short-term bonds serve as the cash component. During prosperous times, stocks perform well; during periods of high inflation, gold excels; in recessions, long-term bonds increase in value; and during severe recessions or economic depressions, cash (short-term bonds) provides a level of defense.

Rebalancing: Harry Browne himself recommended rebalancing once a year. While individual investors may choose to rebalance semi-annually or quarterly based on personal preference, it’s not advised to do it more than twice a year. The goal of investors following the Permanent Portfolio strategy is to invest and then largely ignore the market, checking their account only once a year (or every six months) for peace of mind.

Thoughts on the Permanent Portfolio

Defense: Wouldn’t it be a dream to set up an investment portfolio, rebalance it just once a year, and spend the rest of the time enjoying quality time with family, pursuing hobbies, and traveling the world?

Investors often find it hard to stay calm after making investments because of human nature - greed and fear - but perhaps fear plays a bigger role. This fear comes from knowing that a severe market downturn could lead to losses of 20%, 30% or even more on hard-earned assets. But what if you invested in a portfolio that could limit losses to under 10% in most market shocks and stay within 16% even in the worst situations?

The Permanent Portfolio has only recorded a loss over 16% once in the past 154 years, during the Great Depression in 1932 when it lost 30.6%. Personally, I would exclude the possibility of another Great Depression and consider approx. 16% as the potential maximum loss, which would give a peace of mind when investing in the Permanent Portfolio. 

For one more example, on October 19, 1987, the S&P 500 dropped a historic 20.5% in a single day, known as Black Monday. During that October, the S&P 500 fell 21.8%, while the Permanent Portfolio’s return for the month was -4.5%. By comparison, the All Weather Portfolio, which has decent defensive capabilities, was down 7.2%. Now you can see why the Permanent Portfolio is considered highly resilient.

Returns: If your top priority is protecting against market losses, you could just hold cash. But steady inflation erodes cash value over time, so you need returns that at least exceed inflation.

Let’s compare the returns of All Weather, 60/40, and Permanent Portfolios. Over the last 30 years, average annual returns were highest for the 60/40 portfolio, followed by the All Weather and then the Permanent Portfolio. Comparing returns over the recent five years and ten years, the order is 60/40 > Permanent Portfolio > All Weather Portfolio. In summary, despite its strong defensive qualities, the Permanent Portfolio’s returns are not significantly lower than those of the 60/40 portfolio.

Drawbacks: Over the long term, the U.S. stock market has steadily trended upward. With only 25% allocated to stocks, the Permanent Portfolio's return is likely lower in comparison. Over the past 30 years, the traditional 60/40 portfolio averaged 8.5% annually, while the Permanent Portfolio achieved 6.8%.

One question is whether a 25% allocation to ultra short-term bonds is truly necessary. Even during a severe market downturn, we wouldn't sell all of short-term bonds to buy stocks anyway (if we did, it wouldn’t be a Permanent Portfolio any more). So, it’s tempting to have a lesser allocation to the ultra short-term bonds to increase returns. To explore this, I conducted a simulation with a modified allocation: 30% stocks, 30% gold, 30% long-term bonds, and 10% ultra short-term bonds. Here’s the result:

Modified Permanent Portfolio

The average annual return over 10 years improved from 5.5% to 6.2%, and over 30 years, it went up from 6.8% to 7.7%. However, there’s no free lunch; the maximum drawdown increased by about 3-5%. For example, in 2022, the maximum drawdown worsened from -15.9% to -19.2%.

Conclusion

The Permanent Portfolio is perfect for investors who seek returns above the inflation rate but want to minimize losses during market crashes and avoid frequent portfolio management. While the long-term average annual return was a respectable mid-6% to 7% range, this portfolio limited maximum drawdowns to within -10% in most of past market crashes.

Compared to the Permanent Portfolio, the long-term return of the 60/40 Portfolio is about 1.8% higher. However, for investors who are overly anxious during market downturns, it can be challenging to endure years like 2002, which saw -21.6% return, or 2009 with -30.6% return. The Permanent Portfolio hit its lowest point not in 2002 but in 2001 during the dot-com bubble bust, with a maximum drawdown of -5.4%. In 2008, during the financial crisis, the maximum drawdown was -12.6%, which would have made it relatively easier to stay the course.

On the other hand, it might be challenging to hold on during bull markets because its relative returns are lower, potentially triggering FOMO (fear of missing out). In fact, the Permanent Portfolio might be harder to stick with in a bull market than in a bear market.

For investors seeking slightly higher returns, the modified Permanent Portfolio might be one alternative. This version reduces the cash (ultra short-term bond) allocation to 10%, with 30% each in stocks, gold, and long-term bonds. It increases the 30-year average annual returns by 0.9% but also raises the maximum drawdown by approximately 3–5%. As usual, it’s a trade-off.

Thanks for reading. I wish you success in making smart investments!

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