I hope you’re enjoying these good times as an investor. 2017 was another pain-free 12 months for our Slow & Steady passive portfolio. We ended 9% up on the year.

Coming in the wake of that monster 25% bunk-up in 2016, checking the numbers all year was a soothing ego-balm – about as mentally challenging as telling your mum you got a promotion, or handing over a Christmas present to a child.

The bulls have owned the global stock markets like the streets of Pamplona. It was the kind of year that makes us all look like investing geniuses, as the portfolio numbers below show (brought to you by G-Whiz spreadsheet-o-vision):

• The portfolio is up 52% since we started seven years ago.
• That’s 10.92% annualised, or around 8.5% in real1 terms. The historic real return of an equity portfolio hovers right around the 5% mark, so we’re living through a blessed time, believe it or not. (All the more so as we’re laden with sluggish bonds, too.)
• Emerging Markets was the star performer: up 21% this year.
• The FTSE All Share contributed 13.35%, with the FTSE 100 global behemoths larging it up on a weak pound.
• Our biggest holding – the Developed World ex-UK – brought in a similarly welcome 11.39%, with Europe and Japan scoring a rare victory over the US (which nevertheless hit new highs during the year).

With equities looking flush, it’s no surprise that our annual bond gains pale by comparison:

• UK inflation-linked bonds – 2.24% higher.

• UK Government bonds (conventional gilts) – up 1.64%.

These are nominal returns. Our fixed income assets have actually lost value after inflation.

The Slow and Steady portfolio is Monevator’s model passive investing portfolio. It was set up at the start of 2011 with £3,000 and an extra £935 is invested every quarter into a diversified set of index funds, tilted towards equities. You can read the origin story and catch up on all the previous passive portfolio posts.

But we should never get hung up on recent performance. Our longer term returns tell a slightly different story. Over seven years:

• The Developed World is the clear leader, up a staggering 15.5% annualised.
• Emerging Markets delivered near 10% annualised, but at the cost of some fearsome volatility along the way.
• We’ve only owned Global Small Cap for the last three years but it’s brought home a handsome 16.82% annualised.
• Global property has brought in 9% annualised over three years; it failed to keep pace with inflation with an insipid 2% this last year.
• Conventional government bonds have delivered 5% annualised over the full period – so around 2% to 2.5% ahead of inflation. A good performance by historical standards.

We’ve had a great run, with the portfolio working like the textbook example it’s meant to be:

• Equities are powering up our wealth.
• Government bonds are a handy diversifier, but they’re lagging over the longer term.
• Emerging Markets are hugely volatile and often diverge from the Developed World.
• The US market shows that a single market can trounce all-comers for a decade or more. As we can’t predict which market will win, we stay diversified.

Portfolio maintenance

It’s portfolio MOT time! With every stock market around the world steaming ahead, it’s an auspicious moment to reduce our exposure by moving 2% of our wealth away from equities and into government bonds.

We’re not doing this on a whim, though. We’re simply following the risk management tactic we committed to when we set up the portfolio, redeploying into less volatile bonds in 2% steps every year.

With 13-years left on this model portfolio’s investing clock, we’re now 66/34 in equities versus bonds. The plan is for our allocation to be 40/60 equities versus bonds by the end. We should be well insulated from a sudden stock market crash by that point.

As it is, the US market is richly valued, so I’m more than happy to snip back the Developed World fund by 2% (it’s over 50% invested in the US). That 2% shifts into the UK Government Bond fund. We’ll likely be very glad about that should markets dive in 2018.

We could have made marginal cuts to our other equity positions instead – Global Small Cap, Emerging Markets, the UK’s FTSE All-Share or Global Property – but we left them alone to maintain a healthy level of diversification across asset classes.

Our 2% asset allocation shift also merges into our annual rebalancing move. Every year we rebalance the portfolio back to its preset target asset allocation. Again this is about risk management, as we cream off the profits from assets that have soared in value and plough the proceeds into cheaper markets whose time should come again.

This quarter it means selling a chunk of Emerging Markets and Developed World and scooping up UK Government Bonds and a few Inflation-Linked Bonds in exchange.

Remember, we’re not making a judgement call. We’re just staying in line with the asset allocation we have set.

Increasing our quarterly savings

Now to deal with inflation. The sharp-toothed money nibbler has bitten off 3.9% this year according to the latest Office for National Statistics’ RPI inflation report.

To maintain the value of our contributions, we must therefore ‘inflate’ our own quarterly investments from £900 in 2017 pounds to £935 in 2018 wonga.

We’ll do that every quarter in 2018, although we’re only putting in £931.73 this time. Why? Because the rebalancing rejiggery equals a £3.27 contribution to Global Small Cap. That’s under our platform’s £50 minimum investment limit, so we’ve written it off for the sake of convenience.

Here’s this quarter’s buy and sell:

UK equity

Vanguard FTSE UK All-Share Index Trust – OCF 0.08%

Fund identifier: GB00B3X7QG63

Rebalancing sale: £20.78

Sell 0.102 units @ £203.88

Target allocation: 6%

Developed world ex-UK equities

Vanguard FTSE Developed World ex-UK Equity Index Fund – OCF 0.15%

Fund identifier: GB00B59G4Q73

Rebalancing sale: £881.44

Sell 2.674 units @ £329.60

Target allocation: 36%

Global small cap equities

Vanguard Global Small-Cap Index Fund – OCF 0.38%

Fund identifier: IE00B3X1NT05

New purchase: £0 (Leaves fund pretty much bang on 7% target allocation)

Target allocation: 7%

Emerging market equities

iShares Emerging Markets Equity Index Fund D – OCF 0.25%

Fund identifier: GB00B84DY642

Rebalancing sale: £285.94

Sell 175.964 units @ £1.63

Target allocation: 10%

Global property

iShares Global Property Securities Equity Index Fund D – OCF 0.21%

Fund identifier: GB00B5BFJG71

New purchase: £245.78

Buy 124.697 units @ £1.97

Target allocation: 7%

UK gilts

Vanguard UK Government Bond Index – OCF 0.15%

Fund identifier: IE00B1S75374

New purchase: £1674.16

Buy 10.28 units @ £162.86

Target allocation: 28%

UK index-linked gilts

Vanguard UK Inflation-Linked Gilt Index Fund – OCF 0.15%

Fund identifier: GB00B45Q9038

New purchase: £199.95

Buy 1.059 units @ £188.79

Target allocation: 6%

New investment = £931.73

Trading cost = £0

Platform fee = 0.25% per annum.

This model portfolio is notionally held with Charles Stanley Direct. You can use that company’s monthly investment option to invest from £50 per fund. Just cancel the option after you’ve traded if you don’t want to make the same investment next month.

Take a look at our online broker table or tool for other good platform options. Look at flat fee brokers if your ISA portfolio is worth substantially more than £25,000. The Slow & Steady portfolio is now worth over £38,000 but the fee saving isn’t yet juicy enough for us to push the button on the move yet.

Average portfolio OCF = 0.17%

If all this seems too much like hard work then you can buy a diversified portfolio using an all-in-one fund such as Vanguard’s LifeStrategy series.

Take it steady,
The Accumulator

1. That is, after-inflation [↩]

What caught my eye this week.

I agree with Merryn Somerset-Web, who writes in the Financial Times this weekend that:

I’m concerned – and hardly alone in being concerned – about the bad rap capitalism is getting at the moment.

Despite pretty definitive proof that free markets are the best way to make the world richer, healthier and happier over the long term, some 40% of voters in the UK are positively keen to elect a socialist prime minister, with a view to getting rid of the horrid thing that is capitalism.

Merryn believes fiction is the best way to win socialists over to the wonders of capitalism, but she struggles to find many good candidates. Starving poets and bestselling authors alike tend to argue money is the root of most evils, along with sex, love, and magical rings fashioned in Mordor.

In the end the best pro-market ideas she can come up with are Great Expectations, Time Will Run Back, Kane and Abel, and Career Girls.

Rather stick to the facts? For those like me whose gift-giving runs to the doggedly didactic, here are my six new non-fiction ideas to give that special someone who won’t take offence:

• Adaptive Markets, by Andrew Lo – A critique of the efficient market hypothesis, I may post Lo’s ambitious book down to The Accumulator with a wry “bah humbug!”

• Investing Demystified, by Lars Kroijer – New 2017 edition! Friend of Monevator and ex-hedge fund trader makes the cast iron case for passive investing.

• This Wisdom of Finance, by Mihir Desai – Really interesting attempt to weave beloved humanities and the much-scorned financial world together. (Give it to Merryn, if you’re seeing her!)

• A Man for All Markets, by Edward Thorpe – A humble genius tells us how he beat the system in Las Vegas and on Wall Street.

• Living Off Your Money, by Michael McClung – This new approach to retirement spending has fired the imagination of many Monevator readers. See The Accumulator’s big review.

• Smarter Investing, by Tim Hale – Okay, so even the latest edition is a couple of years old, but it remains my co-blogger’s recommended read for new investors.

And with that, I’ll wish you all a happy Christmas. 🙂

[continue reading…]

The Permanent Portfolio is a strategy for diversifying your wealth. It’s an asset allocation that looks like it was lifted from the Old Testament:

• 25% in cash
• 25% in gold
• 25% in shares
• 25% in long-term government bonds

Okay, so you’re not shipping corn in a Phoenician galley or laying down shekels at the local moneylender. You’re investing in stock market listed companies and government debt.

Nevertheless for an asset allocation, the Permanent Portfolio is about as back-to-basics as diversified gets – the 25% slug of gold giving it a particularly Old World tang.

The Permanent Portfolio’s roots lie in the high inflation era of the 1970s, when investing was simpler. Forget robot advisors or quant funds1 – the only thing most people used computers for was playing Pong or Pac-Man. Few had heard of Warren Buffett, let alone Jack Bogle or Ed Thorpe.

Back then people still held active funds and shares for decades. They phoned or visited their stockbroker. Some buried gold coins in their garden or stashed them under floorboards while they hunkered down for the inevitable nuclear conflict.

Nearly 50 years ago – it’s a different world. You might wonder then what the rather presumptuously named Permanent Portfolio offers us 21st Century investors. Surely we’ve nothing to learn from an approach you could write on a fag packet? (If we still smoked…)

Well, I believe it’s worth pondering the Permanent Portfolio, and its deceptive simplicity. While it’s too straightforward for an investing stamp collector like myself, I recognize it as a thing of investing beauty.

The Permanent Portfolio’s returns have historically been pretty special, too.

Not the highest returns, granted. But that’s not the only way to judge how well a portfolio performs.

The history of the Permanent Portfolio

The Permanent Portfolio was the brainchild of Harry Browne, a US writer and politician.

Browne’s life was quite a journey – he wrote a classic of the US libertarian movement and ran for president – but it’s his evolution as an investor that’s relevant to us.

Beginning his investing career as a gold bug and newsletter writer, Browne morphed into a proto-passive investor. He came to believe nobody knew much about the direction of markets or the economy.

Expansions and recessions were inevitable but impossible to time. Investors should be fearful of inflation as well as deflation, and also of government interventions. (Goodness knows what Browne would have made of quantitative easing!)

Finally cheap passive funds were the investments of choice. Why pay a fund manager when nobody knows anything?

This all resulted in the Permanent Portfolio – the pioneering all-weather asset allocation I gave above.

The Permanent Portfolio is extremely simple, but designed to preserve an investor’s wealth whatever fortune throws at it:

• In good times, the cash and equities should do well.

• In retrenchments, long-term government bonds should shine.

• Gold protects you from calamities – as well as, hopefully, the sort of high inflation (double digits) that prevailed in the 1970s.

Rebalance annually and you might benefit from automatically selling high and buying low. More importantly, you keep your ship on an even keel.

Historical returns from the Permanent Portfolio

According to Portfolio Charts, here’s how a UK Permanent Portfolio would have performed since the 1970s. Note that these are real (inflation-adjusted) returns:

What’s most noteworthy about the Permanent Portfolio is the very low volatility.

• The average 5% real return from the Permanent Portfolio came with a standard deviation 0f just 7.3%.

• In comparison, Portfolio Charts calculates a 60/40 UK portfolio split between shares and bonds gave a 5.9% real return but with far more volatility – a standard deviation of 14.2%.

Here’s an alternative way Portfolio Charts expresses the lows of holding the Permanent Portfolio:

…compared to the 60/40 portfolio:

In inflation-adjusted terms, a 60/40 portfolio lost more than half its value in its worst period. Investors in the 60/40 also had to put up with a 12-year run in the worst case before their portfolio regained its old highs.2

In contrast, at worst the Permanent Portfolio declined just 11% in real terms. And even looking at the darkest period, after four scant years it was back into the black.

True, the higher average returns from the 60/40 portfolio translated into higher total gains if you held it over the nearly 50 years covered.

But you could argue the Permanent Portfolio owner was likelier to keep on holding.

Why the Permanent Portfolio works

The key to the Permanent Portfolio’s stabler returns is its diversification, especially the out-sized allocation to gold.

Clued-up passive investors know that all sorts of simple lazy portfolios of index funds will beat most expensive actively managed ‘solutions’.

But away from websites like this, too many people – especially those who’ve yet to get the passive religion – still hold all sorts of active funds in the name of diversification.

This apparent diversification can be a bit of a mirage, as the following matrix from Columbia Threadneedle [PDF] hints at:

The matrix shows correlations over a three-year period, just by way of illustration. You can see that UK equities and global equities typically move in lockstep. Corporate bonds and property don’t provide much diversification, either.

You need to get into government bonds and commodities to see the all-important red numbers that highlight desirable negative correlations. This is where you hope to own assets that will go up when others (typically shares) go down.

In contrast, holding fund manager A’s Active Superstar UK Equity Booster Fund as well as fund manger B’s Tactical Return Boosting Superstar UK Equity Fund and 20 other active funds that own much the same stuff won’t give you true diversification when the returns hit the fan.

The Permanent Portfolio’s large slug of cash also does much to dampen volatility. In nominal terms, cash never declines.

Diversification and gold

The matrix above detailed commodities in general. Here’s one illustration of how gold in particular has historically proved a diversifier for UK equity investors.

Source: The Gold Council [PDF]

This shows gold was most negatively correlated to FTSE 100 shares at times when the FTSE 100 fell sharply. That’s exactly when you’d most want to see something you own go up, to offset the pain!

It’s especially worth noting because in a crash correlations increase – that is, most assets tend to crash together. If you can own something that doesn’t, you’ll be glad of it.

Bottom line: The big allocation to gold is the oddest but perhaps also the most important aspect to the Permanent Portfolio.

What have you done for me lately?

The Permanent Portfolio regained popularity between the crash of 2008 and the peak of the gold market bull run in 2011.

Scared of plunging share prices and attracted by the allure of gold, new adherents flocked to its defensive asset allocation – with hindsight at a pretty poor time.

Since 2011, the gold price has fallen and stock markets have soared. Permanent Portfolio investors have seen equity-laden investors get richer, quicker.

You can easily see this by comparing the returns from one US ‘permanent portfolio’ fund and the S&P 500:

Source: Fidelity

A few caveats. Firstly, this commercial portfolio is a US fund, not a British one. I’m just using it as an illustration of how the strategy has lagged recently. Also note the asset allocation of this fund is more complicated than Browne’s pure formula. (The fund holds silver, real estate, and even Swiss francs.)

I don’t have the tools to show how a simple UK Permanent Portfolio made up of index funds would have done in recent years.

But as a pointer, a British investing service found that between 2011 and 2015, its own take on the Permanent Portfolio3 delivered a compound annual growth rate of 3.2%.

In inflation-adjusted terms that was an annual growth rate of 1.9% – well below their version of the Permanent Portfolio’s long run real returns of 5.1% since 1986.

As I say, these are just examples given to show that owning a steady performer like the Permanent Portfolio is not a panacea. Someone will always be doing better than you.

But we should appreciate that even during this weaker period, the Permanent Portfolio has achieved its goal of delivering above-inflation returns.

Investing in the Permanent Portfolio

The Permanent Portfolio is a self-reliant DIY investors’ dream. Not as simple as the very simplest global shares and bond mix, admittedly. But a Permanent Portfolio shouldn’t take more than half an hour to set up, and the same again once a year to rebalance.

My co-blogger The Accumulator gave an example setup in his review of lazy portfolios. He used funds. You could use ETFs if you prefer.

Note that long-term government bonds are owned in the Permanent Portfolio. Yes, their returns look weak from here, but they are there for a reason. Using, say, corporate bonds instead will correlate you closer to equities. Shorter duration bonds would bring your bond returns nearer to those of the cash allocation.

Private investors should use bank accounts for their cash component – interest rates are higher.

Gold could be owned via ETFs or coins, via a service like Bullion Vault, or perhaps a mix. (I suggest you review the tax differences).

The equity allocation is invariably given as domestic shares. If I was a UK Permanent Portfolio investor, I might split the 25% between UK and global shares. The London market isn’t as big as the US one, where this portfolio originated. True, you probably won’t get much extra diversification benefit, but I think you’ll get some. It’s not much of a complication. Retaining half in UK shares dampens the currency risk.

US investors might be inclined to add inflation-linked bonds to the mix, but it’s worth noting Browne didn’t suggest this, even after they became available during his lifetime.

British inflation-linked bonds are eye-wateringly expensive right now. I would be in no rush to include them.

Another variant could be to run your equity and bond allocations via an all-in fund like Vanguard’s LifeStrategy, and to manage your cash and bonds separately.

Talking of investment platforms, you would want to think about your portfolio’s size and how you will be rebalancing your allocations when choosing the best broker for you. Our comparison tools can help here.

Needless to say you should be investing in ISAs and pensions to avoid your portfolio being ravaged by tax.

The four horsemen of the investing apocalypse

The contrarian in me suspects it’d be a great time in invest a Permanent Portfolio.

You never read about it anymore. It has hugely lagged other lazy portfolio allocations for years, and people are worried about all its components:

• Gold – “What, you mean gold gold? Haven’t you heard about bitcoin? Or what about something more useful for the 21st Century, like cobalt or graphite? The gold price has been going down for years, anyway. Hardly a store of value!”

• Long-term government bonds – “Are you having a laugh? Putting 25% of my money into expensive interest rate sensitive bonds just as Central Banks start raising interest rates and inflation is rising? Hah!”

• Shares – “What are you on? We’re nine years into a bull market! I’d rather invest in an alpaca farm than put my money into the expensive stock market!”

• Cash – “What, you mean cash in the bank? Now I know you’re taking the piss. I don’t save money for a 1% return a year. That’s less than inflation!”

All these protestations seem reasonable. But not only do most of us struggle to know the future – some of these scenarios are mutually incompatible. (Gold is its usual joker in the pack. The price could do anything.)

The genius of the Permanent Portfolio is something should do well in pretty much all scenarios. Overall that should make up for some under-performance in its other components – at least compared to share or cash-dominated approaches.

Permanently a place for the Permanent Portfolio

Active investing is my passion. At times I’ve approached a hundred holdings of some sort. I’ll also accept higher volatility for hopefully higher returns. The Permanent Portfolio is too simple for me. And realistically, I can’t imagine putting 25% in gold.

All that said, compared to when I first learned about the strategy almost a decade ago – back when I was happily ‘all in’ on equities – my need to diversify has increased. The absolute amount I have invested has grown a lot, and my time horizon has shrunk.

The Permanent Portfolio – and its history of decent returns with minimal volatility – is a useful reminder that simple and stark diversification need not be a recipe for stagnation.

I think those looking to reduce volatility in their portfolios (such as those approaching or recently into retirement) could do worse than spend a few minutes thinking about what it has to teach us.

• Further reading: A good book about The Permanent Portfolio.

1. Yes, I know there were a handful of pioneering quant funds and already some use of computers. But nothing like the algorithmic trading that dominates activity today. [↩]
2. This assumes no new savings. [↩]
3. It uses the FTSE 250 for shares, apparently for performance-related reasons. [↩]