The Permanent Portfolio

coyrls

Ray_Singh-Blue wrote: »

I agree gym sock. I like the permanent portfolio because it's possible for Ray Average to take the broad concepts, and map them to his average life in the UK which includes a house, a pension, and a mortgage.

The concepts as I understand them are to hold something which resists inflation, something which resists deflation, something which does well in a boom and something which holds steady in a bust. Respectively: gold, cash, shares and bonds.

The house takes the place of gold. It is a real world, scarce asset which is unlikely to lose value in time of inflation.

The pension holds its value until term (death) and pays a regular income. Like bonds. The mortgage behaves like a negative bond too. Subtract mortgage from pension to calculate net bonds.

Add cash and shares, keep things roughly proportional, job done.

A lot of the time here we discuss shares and cash investments without integrated reference to house mortgage and pensions. This feels like one way of bringing everything together.

But it's not something ...., it's equal values of each something (25% each). So if your house is taking the place of gold, that would imply that you would need to hold cash equivalent to the value of your house, which doesn't make sense to me.

A_T

coyrls wrote: »

But it's not something ...., it's equal values of each something (25% each). So if your house is taking the place of gold, that would imply that you would need to hold cash equivalent to the value of your house, which doesn't make sense to me.

It sure doesn't make sense. For one thing how would one rebalance the portfolio if it included the house?

Ray_Singh-Blue

Why does that not make sense?

Imagine a really bad recession. Your house could lose 30% of its value, your shares 50%, your bonds 10%. Inflation then drops to -2%

Would you not like to have cash equivalent to the value of your house (and to the value your stock market investments, and to the value of your bonds or pension) in that situation?

Fans of the PP say it provides decent returns in all seasons, with low volatility

masonic

Ray_Singh-Blue wrote: »

Why does that not make sense?

The main reason is that gold and residential property are nothing like each other as asset classes.

Just take the last major stockmarket crash for example. At around the same time, property prices tumbled 30% while gold went up by about the same amount. This would be a time when a PP investor would rebalance from gold and bonds into equities. The opportunity to rebalance from your home into equities did not present, but if it did it's not at all clear how that could be achieved - presumably by taking out a bigger mortgage and investing the proceeds? or by downsizing? There will be a cost to taking on extra mortgage debt, which is easy to discount in the current climate, but interest rates may not be this way forever.

Presumably in times of high inflation one would typically rebalance from gold into cash and bonds, whereas if your home is used instead of gold, you face the same borrowing scenario at a time when the cost of borrowing is likely to be high.

So I think I join A_T in not seeing the sense in the substitutions.

kidmugsy

grey_gym_sock wrote: »

whilst the PP includes long-term conventional (i.e. not index-linked) bonds.

That's because Harry Browne wrote before I-L bonds were available.

Ray_Singh-Blue

Rebalancing:

In the accumulation phase people talk about rebalancing by deploying new money in under-represented asset classes. That's how I'd use this sort of model as a guide.

Alternatively, if your houses became too valuable you'd probably just sell one

coyrls

Ray_Singh-Blue wrote: »

Why does that not make sense?

Imagine a really bad recession. Your house could lose 30% of its value, your shares 50%, your bonds 10%. Inflation then drops to -2%

Would you not like to have cash equivalent to the value of your house (and to the value your stock market investments, and to the value of your bonds or pension) in that situation?

Fans of the PP say it provides decent returns in all seasons, with low volatility

In those circumstances you'd have to use some of your cash to buy a more expensive or an additional house with all the associated costs. In circumstances where it was your house that increased in value more than the other components, you wouldn't have the liquidity to rebalance.

Malthusian

Or you could use some of your cash to extend the house. "Do we really need another loft conversion, darling?" "Sorry my love, I don't control the stockmarket."

Ray_Singh-Blue

Private households in the UK hold the majority of their wealth in property and pensions.

ONS data set Oct 2017.

Median UK property + physical wealth: £138,000
Median UK pension wealth £45,800
Median UK financial wealth £8,900

It seems to that a household focusing narrowly on financial wealth risks missing the bigger picture. A lot of asset allocation models focus narrowly on financial wealth, but here is one which need not. I guess that's my point. Obviously gold is not the same as a house, and you cannot easily sell a bedroom or a year of pension to rebalance.

bowlhead99

Ray_Singh-Blue wrote: »

Median UK property + physical wealth: £138,000
Median UK pension wealth £45,800
Median UK financial wealth £8,900

It seems to that a household focusing narrowly on financial wealth risks missing the bigger picture. A lot of asset allocation models focus narrowly on financial wealth, but here is one which need not. I guess that's my point. Obviously gold is not the same as a house, and you cannot easily sell a bedroom or a year of pension to rebalance.

For some people the pension wealth is a defined stream of benefits which considerably helps planning for the future because the value of those benefits or income flows to support your lifestyle doesn't need to be provided by you out of your other, more controllable, assets.

For others the pension wealth is just another pot of 'financial wealth' with a lack of access depending on age. It can be invested in pretty much any of the things the rest of the 'financial wealth' can be invested in. You could decide for example to allocate its exposures broadly in line with the 'permanent portfolio' if you wanted (though I wouldn't, as in still in the accumulation phase of my wealth building and so would want something with more growth potential).

The property side is only really controllable financial wealth if you're rattling around in a much bigger place than you need and wouldn't mind downsizing to support cashflow or more investments of other asset classes. For the rest of us your house is a way to avoid lots of rental payments (particularly in retirement when you don't have earned income coming in) and so, like a DB pension, it's something that stops you needing X amount of growing our income generating assets. So although it's good to take a holistic view of your finances it's not generally something you can swap in or out when you rebalance stocks and bonds etc.

As an aside, I'm another one who agrees that the stocks component shouldn't be a UK tracker. If the person who originally came up with the portfolio was US based with his US tracker stock market holding covering half the investible market cap of the world, that's quite different from saying we'll 'convert' the portfolio for UK use by using an index that only covers 6% of global market cap, is really heavy on some industries and really light on others.

Also, if you backtest Harry Browne's (US) PP for the last few decades in which the US was pretty much the highest performing and reliable stock market around, and bonds had a 30 year bull run, that 50% of the portfolio would do very well on that long term view and or doesn't really matter if the cash performs or not. Of course it will give you reasonable results overall. But the idea that you'd get a decent growth level from here with only 25% equity exposure seems far fetched. It's perhaps a portfolio for when you have made all the money you want to make and have been put out to pasture.