Kuta Beach

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Saturday, 25 April 2009

Harry Browne's Permanent Portfolio

How should you invest your money? I'd like to talk about what I think is the best way to invest your money. It is called the permanent portfolio and it is invented by a libertarian named Harry Browne. The permanent portfolio is simple. Divide your money in the following way:

25% in cash
25% in gold
25% in government bonds
25% in stocks.

The rationale for this is that you have investments that perform well in any economic environment. Government bonds performs well during deflation, gold performs well during inflation, cash performs well during bear markets, and stocks perform well in bull markets.

When I explain to other people why this approach makes sense, I like to use a medical analogy. The discipline of medicine exists to protect people from death and pain, which are caused by diseases. In order to be healthy, an individual takes steps to immunize himself from various diseases. To immunize yourself from the flu, you take flu shots; to immunize yourself from obesity, you exercise and eat less; to immunize yourself from calcium deficiency, you drink milk; and so forth.

Investing is the same. You invest to protect yourself from death or pain from poverty. Poverty is caused by economic diseases, such as inflation and stagflation. To immunize yourself from inflation, you hold gold; to immunize yourself from deflation, you hold cash; to immunize yourself from a bear market, you hold government bonds; and so forth.

How do you move from the economic theory and actually implement this permanent portfolio in practice? Here in Australia you can buy government treasury bonds from the Reserve Bank. It may be simpler, however, to just allocate your superannuation fund in such a way so that the right amount is in fixed-interest investments, e.g. read MTAA's website about diversified fixed interest. To invest in cash, there are various funds that invest in short-term money markets, e.g. Vanguard Index Cash Plus Fund. Another alternative is to use your super fund to invest in cash or simply put your money in your bank's savings account, which at the moment is government guaranteed. Investing in stocks can be achieved easily using a mutual fund, e.g. from Vanguard or Colonial First State. You can also use ETFs if you're comfortable with it, e.g. from iShares or State Street Global Advisors. Gold is more difficult. Buying physical gold, in my opinion, is dangerous. You can buy gold certificates from the Perth Mint. Your deposit at the Perth Mint is guaranteed by the Western Australian government. Another way you can protect yourself against inflation, I think, is to buy energy and mining stocks, e.g. buy up BHP stock. Even investing in most Australian or emerging markets mutual funds, I think, gives you adequate exposure to energy and mining companies, so maybe gold is not necessary.

1 comment:

Matt said...

You got it *almost* right: The bonds are for deflation, and the cash for recession.