The Brave New Portfolio

CYA: Before I get started, let me remind you that I’m not a professional, I hold no financial certifications, and this article (and entire site) should not be considered professional investing advice.

My portfolio allocation is based closely on Harry Browne’s Permanent Portfolio (PP), but with a twist. I call it the Brave New Portfolio.  I’ll first describe the Permanent Portfolio, then I’ll talk about my personal modifications to the plan. The Permanent Portfolio is an equal mix of stocks, Long-term US treasuries, Short-term US treasuries, and Gold. The reason for this allocation is that each one does well in a specific market condition:

  • Stocks: During prosperous times (e.g. 1990’s) stocks do extremely well. The PP recommendation is to purchase an ETF or Mutual Fund that tracks the S&P500 forhigh diversification in the US market.
  • LT Treasuries: During a deflationary period, LT bonds rise quickly. The PP recommends 20-year bonds.
  • Gold: During an inflationary period, Gold prices rise. The PP recommends holding physical gold bullion, and storing it in multiple locations, preferably in multiple countries to reduce exposure to natural disasters or government takeover.
  • ST Treasuries: During a recession, ST Treasuries help buffer losses in your other asset classes, and also will do well during deflation.

The PP mix is 25% of your money in each asset. When any asset goes beyond 35% due to great returns, or below 15% during times of losses, you are to reallocate back to a 25%mix for each asset class (naturally selling high and buying low). For instance, in the past year most PP’ers have had to sell gold (high) and buy stocks (low).  The idea of strategically allocating (and reallocating) to a constant mix of different asset classes is known as the Modern Portfolio Theory.  The best (and most convincing) book I’ve read on the topic is The Intelligent Asset Allocator.

Over the past 35 years, the PP has resulted in roughly 8-10% CAGR (compound annualized growth rate). But more importantly for someone looking to retire early, it has extremely low volatility. In fact, since 1975, the worst performing year was a 3.9% loss. For those of you invested in stocks in 2008, you will appreciate that the PP returned 1.9% gains (compared to 39% losses for stocks). To be fair, stocks gained 25% in 1995 while the PP only returned 18%.  Historically there are higher returning mixes than the PP, but almost none have been as stable.

The standard deviation on a diversified stock portfolio of the S&P500 over the past 36 years was 17%, compared to 8% for the PP. When you’re planning for a 60+ year retirement, a low standard deviation is a very good thing.

Where the Brave New Portfolio (BNP) deviates from the Permanent Portfolio:

Stocks
The PP recommends your stock allocation is diversified across the entire US market by investing in an ETF or mutual fund that tracks the S&P500. Some even use an ETF of the Russell 5000 for greater diversification. For the BNP, I’ve chosen to use the Dogs Of The Dow investment strategy with my 25% stocks. This is somewhat risky, because it does not have the diversification of the S&P500. However, these stocks are generally good returners and, more importantly, they pay out good dividends, and I’ll feel better about early retirement if I’m paying myself an income of dividends rather than drawing from capital by selling non-income paying investments. (Technically income is income if returns are the same, but the mental benefits of seeing a paycheck is priceless).  In the end, I believe holding these stocks still achieves the goal of the stock holdings within a Permanent Portfolio, which is to gain capital during prosperous times.

LT Bonds
The BNP and PP are identical here. 25% of my money is in Long Term US Treasuries, which are yielding 3.42% dividends (I bought most of mine around 3.7%). Rather than owning the treasuries directly, I purchase ETF’s which track the 20 year treasury. The fees are minimal, and it means I don’t have to keep selling old treasuries that are no longer 20 years, and buying new ones. This is what most permanent portfolio investors do.

ST Treasuries
PP recommends ownership of 1 year treasury notes. My portfolio consists of a combination of 1-yr treasury note ETF’s and 1-3 year note ETF’s. Honestly, it doesn’t make much difference. Both barely move at any time, and both return almost no yield, but offer a nice buffer to a volatile market.

I also use this “cash” to do short term side investments as well. For instance, I just sold $76K worth of short-term treasuries and will be investing in a house flip next week.  It should take 4 months, and then I’ll  put that money and any profits back  into my cash account.

Gold
PP recommends owning mostly gold bullion with possibly some percentage in gold ETF’s. It also recommends storing the gold in multiple countries, preferably on separate continents. I didn’t want the hassle of this (not to mention the risk of getting counterfeit bullion), so the BNP is all in gold ETF’s. I did, however, buy multiple ETF’s which invest in bullion in different countries in order to mitigate some risk. These ETF’s match returns at all times, even on a minute by minute basis. I suppose this makes sense, since any inefficiency would likely be bought and sold by algorithmic traders. Gold is by far the most controversial investment in PP because it pays no dividends, makes no money, and isn’t even that useful as a soft metal. However, it has held value for thousands of years and I don’t see that changing anytime soon. As recent times have shown, when people sell stocks they put there money in LT treasuries and gold, which drives the price up.

Other Money
Outside of the BNP, I do keep about 50K of play money (money I could afford to lose) in experimental investments  such as Lending Club.  I don’t consider this part of the BNP – mostly just to keep my primary portfolio simple and clean.

As for reallocation, I follow the same reallocation strategy as PP for now, which is to reallocate at 15/35 bands – meaning reallocate anytime an asset drops to 15% (buy low) or when it rises to 35% (sell high).  This doesn’t happen often, which reduces the tax exposure of selling assets.  Once I retire, I will probably change that to 20/30 bands, since my tax exposure will be minimized through the fact that my income will be tiny.

Since I’m not yet retired, I do have an income that needs to be invested into my portfolio.  I’ve chosen to save up about $10K at a time and then buy into the asset class which is at the lowest percentage mix.  For example, if stocks are down to 20% of my portfolio while the others are all at 25% or more, I buy stocks.  Once your portfolio is significantly larger than your income, how you invest doesn’t matter much.  But my method reduces the frequency of re-balancing, which in turn minimizes taxes.

If you want to learn more about the Permanent Portfolio, I recommend you start out at Crawling Road.

Looking forward to a good conversation in the comments.


19 Responses to The Brave New Portfolio

  1. I would be interested to see your returns on this. It seems interesting. I think gold will crash on you over the next 2-3 years though, so be mindful of that.

    • Yes, many people say this. Many people were saying it 2-3 years ago as well. The truth is the gold/DOW ratio is still within historical bands:

      http://home.earthlink.net/~intelligentbear/com-dow-au.htm

      The important thing is that you should not be looking at any one asset class by itself, that defeats the purpose of having a mixed portfolio. You need to analyze the portfolio as a whole.

      Let’s say gold bombs next month, a disastrous 50% drop. This means I lose 12.5% of my portfolio, not quite as disastrous. Well that money is going somewhere, and probably not under a mattress. Either it goes into stocks because the European debt crisis is over (doubtful) or treasury bonds because there are signs of deflation. So that asset rises. This drives a re-balance of the portfolio – meaning I buy more gold at half the price, and I sell a bunch of treasuries after a sharp gain.

      If you’re still not sold, I suggest you buy The Intelligent Asset Allocator (linked above) or get it from the library. That book will impress you with both theory and real historical data, and it’s not a long read.

  2. Neo says:

    I am very interested in learning more about this investing approach and also Lending Club. That seems VERY compelling to me, but I have so many questions. I will look more closely at the site. I like the idea behind the Dogs of the Dow and in theory it sounds pretty good because you are effectively buying the biggest companies that are least likely to blow-up at a discount. (although some of these companies have already blown-up and been bailed out) BUT, your portfolio is going to be volatile in the short-term; I can deal with that. So if you are willing to buy a more volatile portfolio, why not add leverage? I am sure there is an ETF/ETN or there will be one soon that has similar investments, but is levered. Worth looking into to boost long-term returns.

    • I’m not sure why you consider this portfolio to be volatile in the short-term,can you explain?

      This asset mix is non-volatile in historical terms, but also in theory – as I described above. The standard deviation on returns was 8% over the past 40 years. It doesn’t get much more stable than this.

  3. Yabusame says:

    Thanks for writing this, I look forward to following all of the links and running down rabbit trails.

  4. Martin says:

    Interesting post. I had not been exposed to this approach before.

    If you were to approach this breakdown when you were basically carrying only one asset class, how would you go about creating that balance if you felt that one (or more) of the asset classes you had to increase in was over-priced. Say for example that you had all gold at a time of economic prosperity, and stock prices are through the roof. In order to balance out the 25% across the board, would you buy into stocks even if they were at historically high levels, knowing you would likely be taking a loss, especially if you had to sell gold at a low?

    Alternatively, if you felt that gold was over-priced now and set to burst (I understand you don’t feel that way), would you still buy gold at these record highs in order to achieve the balance you are looking for or wait for the cycle to turn and try to buy low?

    • If you were to approach this breakdown when you were basically carrying only one asset class, how would you go about creating that balance if you felt that one (or more) of the asset classes you had to increase in was over-priced.

      Actually, I did do this. Before creating this portfolio, I was almost entirely in stock equity (and small amount of cash). And, in fact, given the inverse correlation of these asset classes (which is what makes the portfolio so stable) I don’t see how you can ever avoid the scenario you described. In 2008, stocks were too high. In 2009, LT treasuries were too high. In 2011, I suspect gold is too high. But you can’t predict the future, so you don’t know until the asset dips. But that’s OK, because a 20% correction will only impact your portfolio by 5%. And since that money is probably moving into another asset you own, then it has almost no impact.

      As I mentioned above, any rebalanced portfolio following the Modern Portfolio Theory requires that the investor looks at any portfolio as a whole – and how the assets work together. Gold is down 20% this past month, and stocks dropped 7%. Yet my portfolio only dropped 1.5%. This is to be expected. Next month it might be the opposite, but I don’t worry about it because this portfolio has never been down in a 24-month span. That’s an incredible stat.

      If you believe one asset is overpriced, you have some options. First, you can reduce the amount you want to invest in that asset. For example, you may think gold is too high right now, so you could do a mix of:

      35% stocks
      35% bonds
      15% gold
      15% cash

      If this makes you sleep better at night, go for it! Backtesting to 1975, this mix actually has slightly better returns than PP with a slightly lower standard deviation. I seriously considered this mix before deciding to stick with a 25% equal mix.

      One thing I considered but ultimately decided against was to start out with 15% in gold, then slowly creeping up to 25% as I felt more comfortable. The problem was that that is a form of market timing, and that is almost always a bad idea.

      What asset class are you heavily invested in right now?

      • Martin says:

        I appreciate the detailed response.

        I am currently in a similar situation as you were; almost entirely in equities, spread out over three different accounts. I use two IRA’s (SEP & ROTH), which is mostly an aggressive portfolio of mutual funds. I also have a brokerage account with money to “play around with,” and I dabble here with individual stocks and ETF’s.

        I like the philosophy of your approach, but I am definitely concerned about buying gold at $1600+/ounce. One thing I am considering is keeping my position in stocks, and then if/when gold bursts, start investing in that commodity with the money that I add to my investment accounts each month. This would take away the need for me to sell positions that I am comfortable in to buy gold at what I feel are inflated prices. Even if it took a year (or more) to start buying gold at a price I feel comfortable with, I am young enough that I don’t think would kill me. The goal would eventually be to get close to your 25% across the board, even if it takes a few years to get to that point.

        Thoughts?

      • I considered the same approach for the same reason. The risk is this: gold keeps rising. So let’s say you start with $10K in gold and $40K in stocks – and let’s say gold doubles as stocks lose 50% (drastic example to keep it simple). An equal mix would have resulted in profits, but instead you are down $10K. Now you are at an even mix of gold and stocks, but you got there the wrong way.

        Basically, you lose the benefit of a fixed allocation. Had you started with an equal mix, you would have made $10K, then reallocated back to an equal mix.

        What you’re proposing is market timing/speculating. That’s OK, just be aware that you’re doing it. I decided to bite the bullet, and just get directly to my preferred long-term allocation as quickly as possible to avoid speculation.

        If you do decide to pursue your approach, just be careful you don’t end up riding your current assets down to 25%.

      • Martin says:

        I hadn’t thought of it as trying to time the market, although I now recognize it as being exactly that after reading your reply.

        You have definitely given me some food for thought. Thanks for the help.

  5. […] Purchase price was $76K.  Various fees for purchasing the house were $500.  Next, we calculated $33K in repair costs and $11.5 in closing costs and realtor fees.  The comps (comparable houses sold in the area) predict about $145K after repair value (ARV).  All told, this venture should net about $24K in 4-6 months.  (Realistically $150K is a more likely selling price).  We agreed to split the profits 50/50 with me doing 100% of the financing and her doing 100% of the work, so I would then make $12K on a $110K investment.  If it takes 6 months to sell, that’s roughly a 24% CAGR. There’s a good chance I won’t make that much, but a very small chance of losing money.  I consider this a good investment and compliment to my Brave New Portfolio. […]

  6. John says:

    Great stuff…I never knew about Harry Browne. Im not quite paranoid enough to store physical gold in multiple countries, but the portfolio itself is definitely worth looking into further.

  7. jump says:

    I think I’m going to follow this same approach, I’ve read about this before. My question is, with the Dogs of the Dow approach, they state you buy the top 10 at the beginning of the year and hold for 1 year, then repeat. For those that are still earning income, like yourself, how do you buy stocks within the guidelines of the Dogs investing pattern?

    • Good question. When I need to move new money into stocks I buy whatever stock is in the Current Doggishness that I own the least of.

      There’s also a long thread on the forums that talks about how to reinvest into the PP (independent of Dogs of the Dow).

      The options I considered were:

      1. Collect a large sum (maybe a year) and then invest it all at once

      2. Hold it in a completely different portfolio until you need to reallocate back to 25%, at which point you move that money in.

      3. Reinvest regularly, but invest it evenly at 25% for each of the 4 assets.

      4. Reinvest semi-regularly, and put it into the asset that is at the lowest percentage of allocation.

      They each have positive and negative factors to consider. I chose #4 because it helps keep you at an even split, which is easier to manage. It also has tax benefits since you’re less likely to need to reallocate.

      • jump says:

        Thanks for the reply. It doesn’t sound like you sell any stocks to re-balance like the dogs suggest. That was the part I was curious of. Inside the 1 year mark and cap gains taxes are pretty high. Re-investing at the lowest % sounds like a pretty straight-forward approach.

      • For now, I probably won’t reallocate each year since I’m still buying in and the list doesn’t change much. Once I retire, I will probably reallocate. The only reason I wouldn’t is if the stock is in a taxable account with very high gains and I don’t have capital losses to balance it out.

  8. Dobietx says:

    So, do you keep this allocation now that you are retired?

    • I do not.

      I still think this is a great portfolio strategy, even in retirement. The only problem I have is that I couldn’t quite reach my income needs with my available investable assets. I require a 3-4% payout, which can be achieved with dividends, and interest. But with significant money held in gold and short term treasuries (basically, cash), I couldn’t achieve my income needs. I probably would still be OK, but I would need to sell capital on occasion and psychologically I didn’t want to do this. I just imagined myself stressing over what stocks to sell and when, especially if the market was having a down year.

      Now that my income needs are met with my current portfolio, I will likely move more money into something closer to the “brave new portfolio” as my dividends continue to rise at a rate faster than inflation.

      You can see my entire income generating portfolio here. (This is not all of my investments, just those that pay a cash income)

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