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.

Stocks Going Up?

After so many months of dismal stock performance, it looks as if things are getting better. March this year saw the All Ordinaries rise by about 17 per cent or so. Some say it's the bottom while others say it's a false dawn. Nevertheless, my net worth has increased to about $45,000. I have been receiving dividend payments into my bank account. All up I receive on average about $160 per month in dividends, which is about $5 per day. I think this is enough money to feed myself if I ever lose my job.

Losing my job is a possibility because I only started 2.5 months ago and the 3-month probationary period is almost over, which means my employer might decide to get rid of me. I am quite worried because being unemployed during an economic recession won't be easy, and even though I have enough passive income to cover my food expenses, I don't have enough passive income to put a roof over my head. If I do end up unemployed, I will have to continue living with my parents, which will be very shameful if I am unemployed because I'm sure no parent wants to be around unemployed adult children.

I think one of the worst parts about unemployment is the shame, which means that if I am to be unemployed, I would want to be in a position where I have the ability to hide myself from society. If I am able to isolate myself, there is no shame since feeling ashamed requires an audience.

Investing in Oil Companies

With the recent collapse of Lehman Brothers, shock waves have hit the world markets. The All Ords is at 4700, which is very low. The price of oil has gone down from US$147 per barrel to US$90 per barrel. The price of petrol here in Australia is still high because the Australian dollar has depreciated. One Australian dollar used to buy US$0.98. Now it buys only US$0.80. I am happy that my mutual fund invests about 40 per cent in non-Australian assets because that will definitely boost my returns as the Australian dollar depreciates. I have always said that a home country bias is stupid, and now this currency depreciation proves it.

If I am going to buy shares in a company, I am thinking of buying an oil company. The reason why is because oil seems rather cheap at the moment, which would have depressed the stock prices of oil companies. Another reason is because it can provide me with a hedge against rising petrol prices. Petrol prices are by far my biggest expense. Jack at The Survival Podcast believes that this reduction in the price of oil is temporary and oil will keep going up. Many people who believe in the dominance of China and India believe that oil will continue to go up in the future. The real question then is whether supply can keep up with what is expected to be rising demand. The supply of oil is highly manipulated by cartels like OPEC. In general, suppliers of oil are criminals who control countries. They sell oil to us as if they are drug dealers taking advantage of our addiction. Many say that we are near Peak Oil and that oil producers are lying to us about how much oil they hold. I am scared about the opposite, which is Deep Oil. I am worried that there is plenty of oil in the world but the suppliers are hiding it so that they can extract as much money from us as possible. The Peak Oil versus Deep Oil controversy is far too complicated for me at the moment. Most of the articles on the Internet delve into conspiracy theories.

As Stocks Plummet, My Career Flourishes

I have got a job offer! Let's just say I got a full-time job as an economist at a government department. This job makes sense since I studied economics at university. I'm also very happy because, as you may tell from reading this blog, I have a strong intrinsic interest in economics, finance, markets, and investments. I am therefore doing what I really love.

The bad news is that the last time I checked the ASX200 it was 5283. Now that is low! I remember last year it peaked at about 6400. I don't even want to think about how much money I have lost. All I know is that it is in the thousands. Some people are worse off since they are highly leveraged. But otherwise, I have no debts and no worries. Looking at things from an optimistic perspective, I could say that my investments are just undervalued at the moment and that this current depression is a good opportunity to pick up shares when they are cheap. What a pity the stock market starts to tank right when I don't have enough spare money lying around to invest. In a way I'm happy because I do believe that for a long time the world stock markets were booming too much, especially in Australia. This leads people to believe that the stock market can only go up forever and so people leverage and invest. This drives prices up and creates a bubble. The recent volatility hopefully will pop that bubble completely, allowing me to invest in a bubble-free environment where I can buy mutual fund units for a fair price.

Sticking with the optimistic tone, I am not too worried because I only have about $25,000 invested in shares. The rest of my net worth is in my car, in bonds, and in cash. Some people have millions of dollars in the share market. Any slight day-by-day tremor sees their net worth fluctuate by tens of thousands. But they don't seem worried. They understand that higher risk can lead to higher return.

The Stock Market Strikes Back

Since hitting lows of about 5200 earlier this year, the Australia stock market seems to have rebounded. Today the All Ords is nudging towards 6000. This result vindicates Dollar Cost Averagers like me who continued to invest about $500 per fortnight every Thursday payday no matter how pessimistic the pundits were or how sharp the drops were. Some said things like, "With all the volatility, now is a bad time to invest in the stock market." These people would have missed out on an opportunity to profit.

While the blue line above shows the All Ords for the last three months, the red line shows the S&P500 (American stock market) for the past 3 months. It shows that the American market looks like it's heading for a recovery as well.

There are still uncertainties ahead. Nobody knows what long-term effect the sub-prime property crisis in America will have in the long-run. House prices are still going down in America. The IMF claims the Australian property market is overvalued by 25 per cent and that the risk of a severe correction (or crash) is high. Some people take out loans against their homes to buy shares. Most however take out loans against their property to buy even more property. This is what many Americans did before it triggered a house price crash.

Amscot Online is Best Value Broker

I have been reading Money Magazine's piece called Cheapest Online Broker. At the moment I have an account with Commsec, which charges $19.95 per trade of up to $10,000. But I can do better.

The cheapest online broker is Netwealth, charging $17.99 per trade. However, you can't trade more than $5,000, so in terms of how much transaction costs you pay per unit dollar invested, the best value broker is from Amscot, which charges $19.80 for trades of up to $22,500. For the best efficiency you must invest $22,499 at a time. Of course, saving up that amount may incur cost in the form of opportunity cost of having your money in cash rather than equity. This opportunity cost depends on your earnings rate. If you receive $22,500 every second you work, then this would be fine since one second of that $22,500 in cash instead of equity is not going to cost as much as if you had that same amount out for a few years, which is what would happen if you had a low-paying job. All this assumes that the stocks you buy will go up in value by more than what cash investments would produce.

If you are a buy-and-hold investor, which is what I am, then many people who criticize ETFs criticize the brokerage fees, which they say eat away at investors' profits. However, if you are a buy-and-hold investor and hold the ETF for, say, 40 years or forever (say you bequeath the ETF to charity or children after death) then the brokerage costs amortized over this time period is negligible.

Update: There might be some hidden charges with Amscot: "Clients will be charged $11 inc GST per month for use of amscotOnline Standard. This includes both software costs and ASX royalties. This charge will be rebated in full should you execute a minimum of 3 trades per month."

Three trades per month at $22,500 each trade (for maximum value) means I have to make $67,500 worth of trades per month!

Maybe I'll be sticking with Commsec.