Writing for Humble Dollar, Adam Grossman took a look at some of the investing tenets that underlie the Permanent Portfolio. We’ve looked at the Permanent Portfolio many times over the years for what it teaches about managing risk. The Permanent Portfolio was devised by Harry Browne back in the 1970’s and it called for equal, 25% allocations to stocks, long bonds, gold and cash (or cash proxy). The big idea was that no matter how bad it got, at least one of the four would be going up which would mute losses versus something like a 60/40 stock/bond portfolio.
Grossman explored a little more of what Browne might have been thinking about when he created the portfolio, encouraging investors to ask themselves five questions.
- How much risk can you afford to take?
- How much risk do you need to take?
- How much risk are you willing to take?
- How much do you care about keeping up with the market?
- How important is it to accumulate the absolute maximum number of dollars?
I am most interested in the fourth question about keeping up with the market. Grossman notes that the more you diversify, the greater the difference between the benchmark indexes like the S&P 500(NYSEARCA:SPY) and your portfolio. Someone actually following the Permanent Portfolio to a T will have a much different return stream than the S&P 500 because only 1/4 of their portfolio would be in stocks. In years like 2018 that might be a good thing but in 2019 that might be a bad thing. In reality it would neither be good or bad, the context of that last sentence was about the emotional response to being up much less than the equity market one year for having so little exposure to it.
Grossman appears to be saying that keeping up with the benchmarks is not very important when considered against “the peace of mind that comes with greater diversification.” He’s not wrong but I don’t totally agree. Without question, a path that gets you to a dollar amount that makes what you want your retirement to be a possibility is more important than performance compared to a benchmark. If you’ve done some good planning and determine you need $900,000 at age 65 and you get there at 63 or 64 then it doesn’t matter whether you outperformed or underperformed, how often you beat the market or lagged, all that matters is that you have a dollar amount that should be workable.
All that is where I agree with Grossman about relative performance. If he is saying that relative performance plays no role in market participation, I would disagree with that. According to Yahoo Finance, the S&P 500 is up 25% this year on a price basis. A one year gain of more than 20% is up a lot and up a lot, up that much doesn’t come along that often and you can’t afford to miss out on years like 2019 if your financial plan relies on growth from the stock market.
It is not crucial, IMO, to keep up with the market or beat it, just not miss. If the equity portion of a portfolio is up 20% in an up 25% world, I don’t think that is a miss. The market is up a lot and a gain of 20% is a lot. I would say that a 5% gain for the equity portion of a portfolio compared to a 25% gain for the market would be a miss. The fulcrum for this idea is certainly debatable but if the equity market is up a lot and you look at your portfolio and think it is up a lot then you probably haven’t missed out.
The simplest culprits to point out are mistakes and emotions. A mistake could include putting too much into a lottery ticket biotech (NYSEARCA:IBT) stock. Ten or 11 years ago a reader shared that he put 25% of his portfolio into a company working on a drug for migraine headaches and it imploded. If you took an 80% hit on a stock with a 25% portfolio weighting then you’d have missed out on this year’s up a lot. There are all sorts of emotions that result in bad behaviors like selling out when there’s no need to do so. Ten years ago some large number of the population thought President Obama would not be good for markets. Love him or hate him, the market skyrocketed. Three years ago some other large number of the population thought President Trump would not be good for markets and while it might be too early for “skyrocketed,” love him or hate him, the market is up a lot. I make this point all the time, leave your politics out of your investing. If you didn’t like Obama, then the market went up when it shouldn’t have. If you don’t like Trump, then the market is going up when it shouldn’t. There are countless instances in market history when the market has gone up when it shouldn’t.