The Permanent Portfolio: A Fail-Safe Investing Method?

Investing is complicated. It’s difficult. You need expert help if you’re going to build your wealth so that you can retire on time. Or at least that’s what you’ve been told.

There’s a vast financial industry with a vested interest in convincing you that to be a successful investor you have to:

Follow the daily movements of the markets.
Learn how to analyze the nitty-gritty details of stocks and bonds.
Buy and sell constantly to maximize profit.

The truth is that none of this matters. The truth is that smart investing is simple. And easy.

Most investors are best off putting their money into low-cost index funds. (An index fund is a mutual fund that tracks the broad movements of a stock-market index, such as the S&P 500.) Over the long term, this passive investing approach has been shown to produce above-average returns for patient investors. Why? There are many reasons, but primarily because investing in index funds costs much less than nearly any other method.

In fact, Stanford University professor William Sharpe famously demonstrated that passive investing with low-cost index funds must produce better results than traditional investing. The average return of both methods is the average return of the market. But because traditional investing costs so much, investors taking that path necessarily see smaller returns on their investments.

But there are other ways to explore passive investing besides index funds.

Three years ago, I read a book called Fail-Safe Investing by Harry Browne. This tiny volume, first published in 1999, champions a method of passive investing that Browne called the Permanent Portfolio. And while it’s a little more complicated than simply investing in index funds, the ideas are still fairly simple.

According to Browne, the Permanent Portfolio should provide three key features: safety, stability, and simplicity. He argues that your permanent portfolio should protect you against all economic futures while also providing steady returns. It should also be easy to implement.

There are many ways to approach safe, steady investing, but Browne has some specific recommendations:

Hold 25% of your portfolio in U.S. stocks, to provide a strong return during times of prosperity.

Hold 25% in long-term U.S. Treasury bonds, which do well during prosperity and during deflation (but which do poorly during other economic cycles).

Hold 25% in cash in order to hedge against periods of “tight money” or recession.

Hold 25% in precious metals (gold, specifically) in order to provide protection during periods of inflation.

To use the Permanent Portfolio, you simply divide your investment capital into four equal chunks, one for each asset class. Once each year, you rebalance your portfolio. If any part of your portfolio has dropped to less than 15% of the whole, or grown to over 35% of the total, then you reset all four parts to 25%.

That’s it. That’s all the work involved.

Because this asset allocation is diversified, the entire portfolio performs well under most circumstances. Browne writes:

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.

Browne’s arguments sounded crazy at first — far too simplistic! — but with time, I’ve come to believe he’s on to something. In fact, over the past three years I’ve gradually realized that what I need to is move from investing in index funds to establishing a permanent portfolio for myself. Why haven’t I done so?

The high price of gold, for one. Plus, I’ve never really been sure how to implement Browne’s Permanent Portfolio in real life. I mean, what are the actual steps for making it happen? Fail-Safe Investing is a good book, but it’s long on theory and short on actual details. I’m not a professional investor; sometimes I need to have somebody hold my hand.

That’s where a new book comes in.

The Permanent Portfolio: Harry Browne’s Long-Term Investment Strategy by Craig Rowland and J.M. Lawson is an easy-to-access how-to manual for putting Browne’s investment strategy into practice. This book doesn’t just cover the theories behind this method; it also gives details for putting the theories to work in the Real World.

Here is the promotional video Rowland put together for his book.

Nobody knows where the economy is headed. Nobody knows if economic prosperity looms on the horizon — or if we’re in for decades of rampant inflation. And because nobody knows what’s ahead, nobody knows the best way to save for retirement (or any other purpose).

But with the Permanent Portfolio, you don’t have to see the future. You don’t need a crystal ball to divine the best place to put your money. Instead, you hedge your bets against all possibilities. Sexy? Nope. Safe? You bet. And now that Craig Rowland and Mike Lawson have explained exactly how to put the Permanent Portfolio into practice, I intend to do so. Perhaps you will, too.

Note: This essay originally appeared as the foreword to Rowland and Lawson’s book.

House Hunting, part one: Setting the Stage

It’s been a year since Kris and I began the divorce process. For most of that time, I’ve been living alone in a 700-square-foot apartment in northeast Portland. It’s not a bad place, but it’s never felt like home. Plus, it’s noisy. It’s noisy from the neighbors (and their dogs!), but it’s also noisy from the traffic and from the donut shop outside my window.

This summer, I finally got the itch to move someplace more permanent. Mortgage rates were at all-time lows and I began to get the sense that the real-estate market in Portland might have bottomed out.

“I think I want to buy a condo,” I told Kim before I left for Turkey. During my last few days in town, I began to do some research. I found some places I liked, but prices still seemed pretty high, especially in downtown Portland.

While I was traveling, Kim did a little research of her own. “I think you might have missed the bottom,” she told me. “The market is really picking up.”

When I returned from Turkey, I met with a real estate agent (a Get Rich Slowly reader!) who confirmed what I’d already figured out. The real estate market in Portland had indeed bottomed out, and homes in the city were selling especially quickly. (One place that I really liked sold in just 24 hours. That’s just like at the start of the housing bubble!)

My real estate agent told me that there’s very strong demand in Portland itself, which has kept the prices inflated. But that also means that areas outside of Portland are cheaper because there’s less competition. Good ol’ supply and demand!

I met with my real-estate agent a month ago. We spent two hours talking about what I need in a home, and at the end of it all she seemed to have a pretty good feel for my lifestyle. “If we could find you a small little hobbit home somewhere with low maintenance, you’d be perfectly happy with that, wouldn’t you?” she asked. Yes, I would.

As I say, I met with her a month ago. I had hoped that now, a month later, I might be deep in my house hunt. Unfortunately, it hasn’t even started yet. I hit a snag.

You see, although I have enough money in the bank (or invested, actually) to purchase a home outright, I don’t actually have much of an income. As a result, I’m unable to qualify for a mortgage. Banks don’t care if you have the money in the bank to make the house payment; they want you to have the income to make a house payment. So, after a month of jumping through hoops, the conclusion I’ve come to is that I need to pay cash for a house or not buy at all.

That’s too bad. I had really hoped to take advantage of the low mortgage rates. It’s a perfect opportunity to exercise leverage — to borrow money at a low rate (my mortgage) and make money at a higher rate somewhere else (take your pick of any number of investments that ought to return more than 3% annually, including many dividend stocks).

I haven’t given up, though. I meet with my investment advisor on Monday to see if we can create some sort of income-like money stream. And in case that doesn’t work, I’m talking with Kris about getting my half of the equity out of our house. (We maintained joint ownership even after the divorce.) It’s possible that I could find enough cash to buy a modest place outright. I’m not sure that’s something I actually want to do…but it’s a possibility.

Meanwhile, I’m about to move to a month-to-month lease on this apartment, which isn’t something I really want to do. (It costs an extra $50 a month to do so.) But I feel like my living situation is in complete flux right now, so making firm decisions is tough. It’d be so much easier if the bank would just give me a mortgage!

The Secret to a Rich Life

Every week at Get Rich Slowly, I devoted Fridays to reader questions. I’d select one reader email to share, provide my own feedback, and then ask blog readers to contribute their opinions. It was one of the most popular features on the site.

I hadn’t planned to do that here at More Than Money. For one, I didn’t think there’d be many reader questions. Turns out I was wrong. Less than a week after this site’s “hard” launch, I’ve already received three great topics for discussion.

First up, my long-time friend P. dropped a line after reading the transcript of my WDS talk about personal transformation. She wrote:

I enjoyed your post yesterday, especially as I had my own Ulysses experience this summer. I realize you took significant action steps to get to where you are financially, but the whole time I was reading, I kept wondering how much of what you were able to do was based on money. (Please understand this is not criticism of you or your talk; it’s really just a philosophical debate.)

Certainly there are actions people can take to make themselves happier that don’t cost money (such as your examples from today), but even something as simple as saying “yes” often comes with a price. And so many of your examples were luxury items: travel to foreign countries, skydiving, getting tutored in Spanish. Even going on a massive dating spree.

Money has allowed me to see some amazing places

But as I said, this isn’t about you. Beyond the philosophical, it’s about me.

Mostly, I would say I am happy and lead an awesome life. The one hiccup to me is my job. I can say nothing negative about my job: It pays buckets of money, it has great benefits, great hours, prestige, lots of vacation, and nice co-workers. But it’s not something I’m passionate about. I probably once was, but it’s too familiar now, or old hat, or, perhaps, boring. I feel like if I didn’t have to work as much, I could spend more time doing the things that truly add joy to my life. But many of the things that bring joy to my life, I couldn’t do if I didn’t make this money.

And of course with kids, the ability to take big risks decreases a lot.

Again, I’m not really unhappy, nor am I looking for you to solve my job issue (retiring Dec. 31, 2015!), but I wondered: If someone can’t make a living doing what they love, or make a lot of money, how much of what you talk about is unavailable to them?

This is a great question, and one we’ve tackled many times over the years at Get Rich Slowly. (For instance.) Fortunately, there’s actually a solid body of research into the relationship between money and happiness. Rather than re-invent the wheel, I’m going to share my summary of the subject, which was first printed in the July 2011 issue of Entrepreneur magazine.

The Secret to a Rich Life

There’s a strong correlation between wealth and happiness. Rich nations tend to be happier than poor nations, and rich people tend to be happier than poor people. But money’s impact on happiness isn’t as great as you might think. If you have clothes to wear, food to eat and a roof over your head, more money has only a marginal effect on your sense of well-being. Other factors are more important.

In a 2005 issue of the Review of General Psychology, Sonja Lyubomirsky, Kennon Sheldon and David Schkade looked at years of research to determine what contributes to long-term happiness [PDF]. They found that about half of our happiness is biological, determined by a sort of happiness “set point.” About 40 percent of happiness comes from the things we choose to do, like exercising, setting goals and building friendships. Only about 10 percent of our happiness is based on circumstances like age, race, gender — and, perhaps surprisingly, financial status.

Although your financial situation plays just a small role in your overall happiness, it does affect it. According to a paper published in the April 2011 issue of the Journal of Consumer Psychology, some financial habits bring greater satisfaction than others [PDF].

“If money doesn’t make you happy, then you probably aren’t spending it right,” write authors Elizabeth Dunn, Daniel Gilbert and Timothy Wilson.

They offer several principles meant to maximize happiness, including:

Buy more experiences and fewer things. Material goods depreciate. The day after you buy something, it’s probably worth less than you paid for it. Experiences, on the other hand, appreciate. Your memories of the things you do — vacations you take, concerts you go to — tend to become fonder with time.

Use your money to help others. Personal spending has only a small effect on happiness, but pro-social spending [PDF] — money donated to charity or used to buy gifts for others — consistently produces strong, positive feelings.

Buy many small pleasures instead of a handful of large ones. This one’s tough to hear on a personal level, because I tend to forego daily indulgences for big rewards. But, in the words of the authors, people are usually happier with “frequent doses of lovely things rather than infrequent doses of lovelier things.”

Pay now but consume later. Buying today but paying tomorrow leads to debt — and to unhappiness. Deferred gratification makes us happier, and not just because we avoid debt. It also builds anticipation (which is itself pleasurable) and usually leads us to make smarter choices.

Beware of comparison shopping. If you’ve read The Paradox of Choice by Barry Schwartz, you know that people tend to be happier with fewer options. With fewer choices you’re less likely to make a “mistake” while shopping, and there-fore less likely to suffer buyer’s remorse. Plus, it can be tough to know which features actually matter most. Find a good option, go with it and don’t look back.

What’s the best way to be sure money will make you happy? At the 2010 Berkshire Hathaway annual shareholders meeting — also known as “Woodstock for capitalists” — Warren Buffett’s business partner, Charlie Munger, shared a pearl of wisdom: “The secret to happiness,” Munger said, “is to lower your expectations.”

If you can’t be content with what you have, you’ll never lead a rich life, no matter how much money you earn.

Happiness in Real Life

All of that is theoretical, of course, and P.’s question involves the real world. In the real world, I’ll admit: Much of the change I’ve been able to accomplish, and much of the happiness I currently experience, is because I have the money (and the time) to spend on activities that bring me joy.

What’s more, having savings gives me a safety net. It comforts me. I know that if I take a risk and something goes wrong, I have options.

That said, the things that make me happiest have nothing to do with money. I enjoy writing. And reading. I love working out. And, most of all, I get pleasure from spending time with family and friends — especially time with The Girl.

Related reading: Just yesterday, Paula at Afford Anything published a nice look at how wealth buys time. In many ways, that’s what I’ve been using money to do recently — to buy time. And that’s not a luxury everyone has.

The bottom line? One of my fifteen money mantras is this: It’s more important to be happy than it is to be rich. Money doesn’t matter if you aren’t pursuing a meaningful life filled with family and friends.

Fortunately, P. is already doing that. She’s happy and wealthy. She’s in a good place, and she knows it. In a follow-up email, she wrote:

For now, I’m finding my happiness by getting through my work and living passionately on the weekends (and Thursdays, because I only work four days a week!) and through vacations. My plan is to retire in three years, four tops (my husband is stuck on five — that’s our one money argument). Having a “finish line” also makes it easier to get through.

Since this is my first “ask the readers” column here at More Than Money, I want to turn this around now and ask you what you think. What’s the secret to a rich life? To what degree do you need money to be happy? If you’ve experienced both wealth and poverty, how would you compare the two? What was happiness like in each state? And to get back to P.’s original question: What are some of the best ways to find meaning and joy on a limited income?

Note: Do you have a question for the More Than Money community? Send it in. I don’t have a contact form yet, but my email addresses aren’t hard to guess. (Hint: I have a gmail account.) And the great thing about doing “ask the readers” here? We can cover all sorts of topics, not just personal finance. If you want to ask about blogging or travel or dating or donuts, those are all fair game.