His “permanent portfolio” is a simple and elegant strategy to preserve capital – almost – no matter what happens:Inflation * Deflation * Prosperity * Depression * Chaos.

Cloudy Crystal Balls

A broad-based wealth-protection strategy must readily acknowledge that the future is unknowable; and that unexpected things will happen – indeed, quite regularly.

Consider some of the many jolts to the financial markets since 1970:

• political turmoil with a President near impeachment
• OPEC and the oil embargo
• the U.S. dollar freed from the gold standard
• the severe bear-market of 1974
• double-digit inflation
• the great price convulsion for gold, silver, oil, commercial real estate, farm land, etc.
• the prime rate at 21.5%
• U.S. Treasury bonds at 15%
• money-market funds at 17.5%
• third-world debt threatening to capsize the banking system
• growing Asian economic influence
• the great bull-market starting in the 1980s
• the S & L crisis
• drought in the U.S.
• the junk-bond crisis
• the 1987 stock market crash
• the fall of the Soviet Empire and the rise of capitalism worldwide
• the growing U.S. debt of trillions of dollars
• a political establishment unwilling to curb entitlements
• another President threatened with impeachment
• an unprecedented controversy over a Presidential election, effectively requiring the U.S. Supreme Court to choose a victor
• a major terrorist attack on U.S. soil, with a resultant preemptive U.S. attack on another country
• the U.S. federal deficit further bloated due to increased defense spending plus a massive expansion of entitlements
• the  sub-prime mortgage crisis threatening US financial institutions

It’s fairly safe to say that not one of these exogenous shocks was expected – the world was virtually unprepared for all of these events!

This begs the question:

When, where, and what will be the next surprise?

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Not All Asset Classes

Are Created Equally

How did various asset classes react to some of these difficult situations?

Let’s consider:

·        30-year US Treasury Bonds

In the early 1980s, yields on these bonds reached 15%! Imagine buying such bonds and locking in 15% for 30 years! But that’s not all. For the next 20 years interest rates drifted down and down. And what happens to long-term bonds when interest rates significantly decline? Bondholders enjoy massive capital gains! And these gains kept coming for 20 years! Doubling and tripling bond values!

The last time we’d seen large gains from bonds was during the Great Depression. During that time of deflation, when real estate and stock prices sank precipitously, interest rates also fell and, again, bondholders enjoyed out-sized capital gains.

One alternative here: in the event of massive Federal spending in the future, which would threaten the stability of the US dollar, a mix of world bonds - bonds from various developed countries - might be the prudent course.

·         Gold

The price of gold has a habit of sleeping, sometimes for decades, but then, rousing violently. We’ve seen this happen recently (2007/2008) with gold breaching $1000 after doing nothing for over 20 years.

The last time we saw such interest in gold was 1980 – a time of double-digit inflation and a weak US dollar. Today, of course, the threat of serious inflation begins to loom large once again, a result of national overspending and an easy-money policy.

Gold is also a traditional refuge in times of political turmoil, war, and even natural disaster. It is considered to be a universal currency, and people around the world tend to fall back on this medium of exchange when confidence in paper money wanes.

·        Stocks

Spectacularly rising stock values is a hallmark of prosperity. We all know that when stocks are good, they can be really good. The Dow Jones climbed from 1000 in 1982 to 14,000 by 2007.

·        Cash/Treasury Bills

Cash is particularly valuable in a deflationary economy as it becomes progressively worth more as prices fall – because you can buy more with it. Cash is also nice to have when interest rates are high as one can earn good yields even in a money market account. At any given time, at least one asset class tends to be cheap, and at those times it’s good to have cash in order to take advantage of the bargain opportunities.

4 Asset Categories:

Doing Well at Different Times

A bullet-proof capital preservation portfolio must be designed to survive a catastrophic event. History, as we have seen, offers to us a variety of calamities, ones of differing character. These debacles affect different asset classes in different ways, with some suffering degradation while others advance.

Stated another way,  when surprises to financial markets erode some asset classes, we would look to other elements of the portfolio to make up the difference.

That said, we must understand that there is no such thing as perfect protection against all calamity, the accomplishment of which would mean the elimination of risk – which is not possible in this world.

Protection, even when it’s available, will likely be imperfect; and there will be times when no asset class does particularly well.

And the prudent investor, no matter how far-sighted one is, must be prepared for the "exogenous shock," the totally unexpected from left field. What might that be? Well, of course, by definition, we cannot know that... but... what if, for example, gold somehow lost its appeal as the universal de facto currency of last resort? what if world governments defaulted on their bonds, instead of simply printing money to pay their debts?

It is almost foolish to speculate on these things. But the important point for us is that the perfect hedge does not exist. And for those who think that stuffing the mattress with money is safety, allow me to remind you that mattresses can burn; and people can forget where money was stashed; or it's stolen, sometimes by family members; and, in any case, money like this will soon be devoured by the inflation menace.

A capital preservation portfolio is designed, and to be selected, not for maximum growth, not for beating the market, but for the most basic reason, that of survival in the face of unusual calamitous events.

Let’s look more closely at the four major asset classes and review when or under what economic conditions they are likely to do well:

Stocks:                    

• good economy, prosperity                                       
• national and world political stability                                  
• consumer confidence, investment in the future                                        
• declining interest rates                                        
• low to moderate inflation                

30-Year US Bonds:          

• declining interest rates                                  
• low inflation                                      
• deflation and depression

Gold:                                    

• rising interest rates, inflation/hyper-inflation                                               
• international calamity/chaos/war/assassination                                          
• political instability and uncertainty                                        
• disruption of energy and food production                                     
• erosion of the rule of law/property rights                                     
• severe natural disasters                                     
• falling US dollar and currency debasement                                    
• confiscatory government policies & high taxes                                     
• fear, flight to safety, no confidence in future

Cash/Treasury Bills:       

• deflation and depression                            
• tight money and high interest rates                             
• liquidity for emergencies/opportunities

You should notice here that, given a certain economic event, one asset class can suffer while another will strengthen.

How Has This Strategy

Performed Over Many Years?

For 33 years Harry Browne reported results of his Permanent Portfolio. The average annual gain was 9.2% for 33 years. $1000 invested in 1970 became $20,260 in 2003. (Past performance is not a guarantee of future results.)

Harry Browne’s Portfolio Results: 1970 - 2003

1970   +   4.1%	1980   + 22.1%	1990   –  0 .7%	2000   +   2.7%
1971   + 13.4%	1981   –   6.2%	1991   + 11.5%	2001   –   1.0%
1972   + 18.7%	1982   + 23.3%	1992   +   4.0%	2002   +   7.2%
1973   + 10.6%	1983   +   4.3%	1993   + 12.6%	2003   + 11.8%
1974   + 12.3%	1984   +   1.1%	1994   –  2 .4%	2004
1975   +   3.7%	1985   + 20.1%	1995   + 16.6%	2005
1976   + 10.1%	1986   + 21.7%	1996   +   5.2%	2006
1977   +   5.2%	1987   +   5.3%	1997   +   6.7%
1978   + 15.0%	1988   +   3.6%	1998   +   7.4%
1979   + 36.7%	1989   + 14.8%	1999   +   4.7%

As previously mentioned, this portfolio is not designed to beat the S&P 500, though that could happen in some years. This strategy offers the prospects of modest growth, plus – most significantly -- a good measure of protection against future mishap.

It does not appear, at the time of this writing, that world peace or sound governmental economic policy will overwhelm us any time soon. As I look at the world today, many major threats come to mind, ones that offer no easy solution and seem likely to become worse before they become better.

Who Should Consider Investing In

This Capital Preservation Portfolio?

Ask yourself these questions:

How often do you wake up in the morning apprehensively wondering what the television news will bring you?

Do you worry about another 9/11, maybe one of even greater proportions, sending the country and the world into economic recession or depression?

Are you concerned about the growing threat of rising inflation; or worse, runaway inflation due to massive government deficit spending and unfunded entitlement programs?

Will terrorists find a way to shut down oil fields, catapulting the price of crude to $200 or beyond, sending shock waves throughout the global economy?

We all hope and pray for world peace. But what economic (and otherwise) tremors await us in the next 30 years? If the past is any guide to the future, we have cause for concern.

If you are bothered by any of the above thoughts, you should seriously consider a capital preservation portfolio -- it's also a very good choice for anyone who doesn't sleep well at night having most of one's assets in the stock market.

High Cash-Income Investing (HCI)

vs.

Capital Preservation Portfolio (CPP)

Some might be wondering which of these programs to employ.

HCI is the best strategy for “normal” times; there is a large corpus of academic research pointing to the superiority of HCI over time. HCI is the preferred strategy for all economic conditions – short of major calamity.

Of course, none of this helps us very much as the severity of future catastrophes is presently unknown - and I only present the obvious when I state that once a calamity strikes, it's too late to gain the full benefit of CPP. 

In the event of a truly devastating situation, CPP will trump all. It is only prudent to assume that during the next 10 years there will be at least one major shock to the world and financial markets; as I write this, I find myself discounting my own words as I expect to see more than one of these unpleasant events.

One principle seems to be clear: the more capital one has, the more sense CPP makes, as preservation might supersede the need for significant growth. Again, there are no guarantees in investing; indeed, regarding anything in life - but, I think CPP offers the best chance for keeping what one has. In 25 years of searching, I've found nothing that makes a sounder case ... let me know if you have something better.