Permanent Portfolio Strategy: A Wealth-Creating Tool

A permanent portfolio strategy is one where the allocation of all the financial instruments is done in such a way that the portfolio would generate profits in any economic climate or condition. Read on to understand how this works

Volatility is something that has been a very evident characteristic of the stock market. Every week ushers in a new wave, representing different stocks going up and down and dancing to the tune of news and views impacting the market. And then of course there are certain shattering events such as the ongoing pandemic that takes this volatility to the extreme. As a result, the market spins downwards. These crashes cost investors a lot, especially those who invest for the short term. Also, such a period becomes witness to the entry of novice investors who have very less risk appetite and knowledge about the market but aspire to acquire great returns. The volatility doesn’t spare anyone and creates for them a bitter experience.

Permanent Portfolio Strategy
Given this fluctuating state of the market, investors, both matured and new, need to follow a proper investment plan, one of this being the permanent portfolio strategy. It’s something that can help an investor remain in the market for a long time and become less prone to extreme volatility. A permanent portfolio strategy is one where the allocation of all the financial instruments is done in such a way that the portfolio would generate profits in any economic climate or condition. Moreover, it does not require continuous monitoring. Here, the portfolio allocates resources into each of the four asset classes i.e. gold, equity, debt and cash in equal proportions of 25 percent each.

The portfolio can be of two types, one with rebalancing of the weightage of asset classes and one without any such rebalancing. The concept was first devised by Harry Browne, a freemarket investment analyst in the 1980s. The strategy can be used by any investor to earn stable returns while not risking much. However, it is most suitable for a passive investor i.e. one who does not have time or knowledge to carry out in-depth analysis of the portfolio and its assets. Such investors usually look out for safeguards against inflation and depreciation of their money. A permanent portfolio is a great way to invest for an investor with moderate return expectation without keeping track of everyday happenings in the market.

The key factor in using a permanent portfolio strategy is that it allows the investor to earn decent returns without being too bothered about both internal and external triggers that create upswings and downswings in the market. This is because:
•The permanent portfolio does not require much involvement or monitoring from the investors.
• The portfolio is used to generate stable returns instead of astronomical profits for the investors.
• The portfolio does not require extensive knowledge about different asset classes from the investors.

Risk Comparison
One of the most important characteristics of a permanent portfolio is that it reduces the risk of the investor by diversifying into asset classes. Hence, the risk involved in a permanent portfolio is less as compared to the individual asset classes i.e. gold, debt, equities and cash. Given below is a chart which depicts the results of 10 years’ of back testing. It shows us the returns and the risk involved in each of the asset classes and compares it with the risk and returns of a permanent portfolio.

As shown in the above data, a permanent portfolio is a balance between high risk and return instruments like equity and gold and low risk and return instruments like cash and debt. This is because the portfolio is designed in such a way that each asset class hedges against the other asset classes when it comes to performance during different economic conditions. Here is an example to help understand this: During 2008 i.e. during the global financial crisis, the equity markets hit rock bottom with a fall of 55.38 per cent and gold gave a return of 14.35 per cent. Historically it has been observed that when the stock market is most pessimistic, gold performs very well. The same situation was observed during the 2020 market crash due to the spread of the corona virus across the world.

Cash or liquid funds remained stable at 8.82 per cent returns while long-term debt funds generated a huge 26.02 per cent return as compared to the previous year’s 6.38 per cent as the interest rates fell and bond prices rose. However, during 2009, after the great financial crisis, equity class on an average gave a marvellous 88.02 per cent return along with gold giving 32 per cent return. Cash or liquid funds fell slightly to 5.09 per cent due to the fall in interest rates while debt funds gave a negative return of 6.31 per cent as a result of the spike in securities’ yield. So, if you had permanent portfolio in place during the 2008 market crash, your portfolio wouldn’t have been affected much because of the cushion of debt, gold and cash or liquid funds.

Advantages and Disadvantages
Since the portfolio is meant to deliver in the long term it has the ability to withstand market fluctuations and make sure that it has no effect on the returns. And as the returns are to be realised at the end of a long term, you benefit from the compounding effect of returns gained as per the chosen instruments. Given the fact that these investments are for the long term, constant revision is not required and therefore there is no need for monitoring too.

There are some disadvantages too. Since the portfolio is not revised frequently, an investor misses out on different opportunities for gains that he could have earned over the short term. Holding cash for use in times of emergency is wise but it excludes quick growth. Also, the returns are consistent but remain on the average side and not as exponential as compared to returns one can earn through actively managing investments in stocks.

Conclusion
As discussed, a permanent portfolio strategy is something that can benefit an individual in the long run and is a very safe mode of investment. An investor who wants to play safe and remain secured through any number of economical setbacks should opt for this strategy. It can be a very good tool for someone who wants returns in the long term and even if it yields average return the compounding effect ensures that the benefits are not affected at the end of the term. In fact, one can choose this type of strategy to ensure a successful and good retirement fund.