*Updated August 23rd, 2018 by Ben Reynolds
*

Former Libertarian presidential candidate Harry Browne is the originator of the Permanent Portfolio. He popularized the concept in his book Fail-Safe Investing.

The portfolio consists of 4 equally weighted assets:

- 25% Broad stock market (SPY)
- 25% Long-Term Government Bonds (TLT)
- 25% Gold (GLD)
- 25% Short-Term Treasuries (SHY)

**Note: ** The Permanent Portfolio book covers the portfolio in great detail.

The Permanent Portfolio’s high percentage of gold and short term treasuries is immediately noticeable. Each item in the portfolio is meant to do well in different economic regimes. The 4 economic regimes the Permanent Portfolio considers are:

- Inflation (gold)
- Deflation (long-term government bonds)
- Recession (short-term treasuries)
- Prosperity (stocks)

The portfolio simply weights each economic regime equally. The portfolio is then rebalanced annually.

So how has the Permanent Portfolio done?

It has performed extremely well over the last 4+ decades. Since 1972, the portfolio has had a CAGR of 8.9% per year, with a standard deviation of only 7.8% using annual data.

**Note: **Click here to download this data as an Excel spreadsheet.

**Sources: **Return data prior to 1994 for stocks, prior to 2005 for gold, and prior to 2003 for long-term bonds and short-term bonds is from the now defunct Crawling Road site. All other data is from Yahoo! Finance, for the following ETFs: stocks (SPY), gold (GLD), long-term government bonds (TLT), short-term government bonds (SHY).

The Permanent Portfolio has generated solid returns with very low volatility because it invests in assets that have very little correlation to one another, as the correlation table below shows.

**Source: **Same as previous image

Stocks, long-term bonds, and gold all have near 0 correlations to each other. They are the only 3 *established* asset classes I’ve encountered that maintain low correlations over long periods of time.

**Cash & Leverage**

The short-term bond portion of the Permanent Portfolio is a cash substitute. Cash/short-term treasuries shouldn’t be viewed as a separate asset class. Instead it should be viewed as *leverage*. Putting 25% of your portfolio into cash (like the Permanent Portfolio does) is the same thing as having a portfolio that is 75% leveraged; the opposite of borrowing money to invest.

The Permanent Portfolio is really 3 ‘risky’ (as opposed to ‘riskless’) asset classes (stocks, long-term government bonds, gold) leveraged to 0.75 instead of fully invested.

But what would happen if we invested only in the 3 risky asset classes in the Permanent Portfolio?

If you invested equally in stocks, long-term US bonds, and gold for the same period (1972 through 2017), your portfolio would have a CAGR of 9.7% with a standard deviation of 10.0%. This compares favorably to the original Permanent Portfolio’s CAGR of 8.9%, although the original Permanent Portfolio’s standard deviation is just 7.8%.

**Source:** Same as previous image

While risk is increased somewhat by removing short-term bonds from the Permanent Portfolio, the portfolio’s annualized returns are increased. There are additional steps one can take to improve upon the Permanent Portfolio concept.

**Dividend Aristocrats Improve Permanent Portfolio Performance**

Dividend Aristocrats have historically outperformed the stock market with less volatility. They tend to do better in recessions (while still posting negative returns on an absolute basis) versus the broader market.

The Dividend Aristocrats are a group of ~50 stocks with 25+ years of *consecutive *dividend increases in the S&P 500 that meet certain minimum size and liquidity requirements. They are high quality blue chip dividend stocks.

The Dividend Aristocrats generated a CAGR of 12.1% from 1990 through 2017, versus 9.3% for the S&P 500. Performance starts in 1990 because that’s the first year of data I’ve found for the Dividend Aristocrats.

The Dividend Aristocrats had annual price standard deviation of 13.9% versus 16.7% for the S&P 500. The image below shows performance by year for the two.

**Note: **Click here to download an Excel spreadsheet of Dividend Aristocrat returns.

**Sources: **Dividend Aristocrats data from 1990 through 2011 from Ploutus. Dividend Aristocrats data from 2012 and 2013 is from S&P. Dividend Aristocrats data from 2014 through 2017 is from Yahoo! Finance for the Dividend Aristocrats ETF (NOBL). S&P 500 data is from same sources as listed previously.

As one would expect, replacing the stock market portion of the unlevered (no short-term bonds/cash) Permanent Portfolio with Dividend Aristocrats significantly improves both portfolio return and volatility.

From 1990 through 2017 replacing the S&P 500 (‘stocks’) component with the Dividend Aristocrats increased CAGR from 7.7% to 8.5%, and reduced annual standard deviation from 7.1% to 6.8%.

**Sources: **Same as previous

**Risk Adjusted Weights**

The equal weights of the Permanent Portfolio do not spread risk among assets in an optimal manner.

By weighting each asset class of the Unlevered Dividend Aristocrat Permanent Portfolio by inverse volatility as opposed to equal weighting, we can further improve upon the Permanent Portfolio while still adhering to the portfolio’s underlying principles.

This approach is called risk parity. The idea is to take an equal amount of *risk* (typically measured by standard deviation) for each asset class, rather than put an equal amount of *weight* in each asset class.

Gold has historically had a higher standard deviation than long-term government bonds and Dividend Aristocrats. The Dividend Aristocrats index has been about as volatile as long-term government bonds.

Taking 10 years of annual returns for each asset class to calculate standard deviation at the beginning of each year allows us to calculate risk parity weights each year for the unlevered Permanent Portfolio with Dividend Aristocrats. When Dividend Aristocrat returns weren’t available (prior to 1990), S&P 500 returns were used to calculate standard deviation.

This approach actually reduces CAGR very slightly from 8.5% to 8.4%, *and* increases standard deviation from 6.8% to 7.1%. This runs counter to what I expected, and shows that the ‘naive’ equal weighting approach has merit with truly uncorrelated assets. The return series for both weighting schemes is below.

**Source: **Same as previous

**Final Thoughts**

The Permanent Portfolio works by spreading risk across uncorrelated asset classes and harvesting correlation gains by rebalancing annually. The portfolio has historically done very well on a risk adjusted basis.

Replacing the total stock market section of the permanent portfolio with Dividend Aristocrats has historically significantly improved the portfolio. Surprisingly, using risk parity weightings has not improved the Permanent Portfolio.

The Permanent Portfolio is an excellent option for risk averse investors and retired investors who need to make solid returns on their investments while avoiding large drawdowns. Large draw downs are significantly worse for investors who are already cashing in their portfolio on a regular basis as it forces you to ‘sell low’.