Investing in assets whose returns are not correlated to one another is key to reducing risk and portfolio drawdown while producing stable returns. Harry Browne’s long-term investment strategy was referred to as the “Permanent Portfolio” and serves as a great base upon which to build the conversation on risk mitigation and asset correlation.
- Define the Permanent Portfolio
- Define asset classes
- Assess economic conditions
The Permanent Portfolio
According to Browne, a permanent portfolio should provide safety and stability, protecting an investor against an unknown economic future while also providing steady returns. To achieve these goals, Browne finally boiled-down the strategy to 25% U.S. stocks, 25% long-term U.S. Treasury bonds, 25% cash, and 25% gold.
While the approach may appear simple, it is far from simplistic, reflecting a sophisticated understanding of economics and financial history.
“The portfolio’s safety is assured by the contrasting qualities of the four investments – which ensure that any event that damages one investment should be good for one or more of the others. And no investment, even at its worst, can devastate the portfolio – no matter what surprises lurk around the corner – because no investment has more than 25% of your capital.” – Harry Browne
This portfolio strategy works because capital is spread to various assets, each with their own risks and with price performance not totally correlated to one-another.
What are Asset Classes?
In brief, an asset class is a grouping of assets based on similarities in financial structure, markets traded, geopolitical risks, and/or price movement correlation. While the Permanent Portfolio referred to four primary assets (stocks, bonds, cash, gold), it is also a slightly dated model. For example, at the time this portfolio strategy was created, Swiss Francs were still backed by real assets and cryptocurrencies did not yet exist. For our modern, diversified portfolio, there are six classes of investable assets:
- Income Assets
- Cash & Equivalents
- Alternative Investments
Against Economic Conditions
There are four primary economic conditions with which a diversified investment portfolio must be able to contend. This is why diversification across asset classes is of key importance. These economic conditions are:
The safest way to approach diversification against adverse economic conditions is to take a neutral stance, with the potential for any economic condition materializing equally weighted. This way our portfolio can achieve real returns in any market without relying on market timing or trading picks.
So, What’s the Point?
The point is that most investors take on too much risk without considering the opportunities that come from stable returns and steady income. Proper portfolio diversification provides risk management. To reiterate: no – a bunch of altcoins does not diversify one’s portfolio.
Portfolio diversification comes from allocating capital across asset classes, not into asset classes.
Now, let’s take a look at each of the asset classes mentioned earlier. What are they? What research is needed to understand each asset class? What investment opportunities are available in each asset class?
Learn more about stocks in the next study guide.
A grouping of assets based on similarities in financial structure, markets traded, geopolitical risks, and/or price movement correlation.
In economics, deflation is a decrease in the general price level of goods and services. In cryptocurrencies, deflation is a decrease in token supply of digital currencies.
The present state of the economy in a country or region. The conditions change over time along with the economic and business cycles, as an economy goes through expansion and contraction.
In economics, inflation is an increase in the general price level of goods and services. In cryptocurrencies, inflation is an increase in the coin supply of digital currencies.
Harry Browne’s long-term investment strategy “The Permanent Portfolio” seeks to increase volatility across four asset classes to achieve stability across the whole portfolio.
Economic condition in which there is relatively low unemployment and high total income, leading to high purchasing power (if the inflation rate is kept low).
Economic condition in which the economy declines significantly for at least six months. That means there’s a drop in the following economic indicators: real GDP, income, employment, manufacturing, and retail sales.
- Investor.gov – What is diversification? https://www.investor.gov/additional-resources/specialized-resources/youth/teachers-classroom-resources/what-diversification
- The Permanent Portfolio, Wiley, 2012, by Craig Rowland