The decision to make an allocation to the Permanent Portfolio was easy. Deciding how much to allocate to it proved to be much more of a challenge and has lead me to start the development of a comprehensive approach to managing my capital. I have come up with five main categories or types of portfolios with the following allocations:

Permanent Portfolio

Basic Permanent Portfolio in simple form: Equal weight allocation of 25% to each SPY, GLD, TLT, SHY. The goal of this portfolio is to gain exposure and take part in the wealth creation of the market while having some protection against the high volatility and distortions created by the political forces. Currently I have a 13.3% allocation to this portfolio and will be taking that up to the 40% level by the end of the year.

Variable Portfolio

Made up of more active trading strategies, mainly trend and rotational portfolio strategies. I currently have a 0% allocation to this portfolio as it will take me a few months to combine the strategies I have in mind into a cohesive system. I will be sharing these strategies here as I finalize them.

Direct Portfolio

Made up of investments in which my decisions and actions have a direct influence on the results obtained. This may included starting new businesses, investing in tools and materials for ongoing concerns, or providing micro-lending to small businesses and people I know and trust. The goal of this portfolio is to provide diversification, expand my knowledge and skills, and grow my network through commerce.

Living Portfolio

Held in cash or money market accounts. This portfolio will act a safety buffer and source of funds during periods of aligned poor performance from the three portfolios above. Can also be used as a source of temporary funds to aid in rebalancing individual portfolios. Can also be a source of funds for unexpected expenses or opportunities that require funds quickly.

Doomsday Portfolio

Made up of physical assets which can be used to seed the rebuilding of capital in case of a doomsday type event. The requirements I have for assets to be included in this portfolio is that they must be widely recognized and useful to other people or be directly useful to me without additional inputs. Some examples are: gold and silver bullion, recognizable coins that can be purchased at or below the metal value they are made from (nickels and pre 1982 pennies are easy to procure), seed kits, food products with long unrefrigerated shelf life, hand tools and materials for constructing things, hand tools for farming, tools for defense, and wood for an energy source.

Notes:

If trading was not such a passion of mine or if I didn’t think it would be profitable I would probably eliminate the Variable Portfolio and distribute its allocation to the Permanent Portfolio and Direct Portfolio.

One asset I have yet to properly work into this framework is real estate. I see owning versus renting a residence as a pretty even trade off, both of which should be treated as a living expense. Beyond a residence though, it does seem like a good time to start thinking about adding some real estate as part of my total portfolio. Currently farm land is very interesting to me as I am a big proponent of the real food movement, a la Polyface Farm, and think there are a lot of opportunities in this area.

I haven’t given the strategy much thought for quite some time so I read Harry’s book Fail-Safe Investing as a refresher. Only a small portion of the book deals with the composition of the Permanent Portfolio, but it is worth the read if you are not familiar with Harry’s 17 Simple Rules of Financial Safety.

The Permanent Portfolio has three requirements: Safety, Stability, and Simplicity. The allocation is: 25% Stocks, 25% Bonds, 25% Gold, and 25% Cash. Positions are rebalanced on an annual basis when any one of the position’s allocation breaks the range of 15% to 35% of the portfolio. That’s it. The idea is to be able to profit in any of the four major market environments identified by Harry: Prosperity, Inflation, Tight Money or Recession, and Deflation.

So how has this strategy performed? Quite Well:

While not outperforming in total return the Permanent Portfolio was able to capture most of the upside of Stocks, Bonds, and Gold over the last 22 years while experiencing only half the volatility.

Stats by 5 Year Period

Can the Permanent Portfolio be improved?

Considering how well the Permanent Portfolio has done in the past 3 years and noticing too that Stocks, Bonds, and Gold are practically at all-time highs it may feel like a bad time to put this strategy to work. It is hard to resist adding some tweaks to better position the strategy for what you think may be coming in the future. But this can quickly add a layer of speculation violating the core principle of the strategy: understanding the future as uncertain.

The one aspect open to modification is the selection of assets used in each category. Harry emphasized this point as crucial for the success of the portfolio. For the Stocks portion of the portfolio he recommended buying three 100% invested broad-based stock mutual funds to protect against any mistakes any one fund may make. For bonds he suggested buying directly the longest term Treasury bond available and rolling on a regular basis your holdings closest to maturity into the longest term available. For gold he points to buying gold bullion. And for cash only short-term Treasury securities.

The strategy was developed before the time of ETFs. While using ETFs shifts the risks involved, their prevalence and accessibility make it easy to implement the Permanent Portfolio. The above baseline performance history was compiled using an ETF based strategy, simply holding 25% in each; SPY, TLT, GLD, SHY.

Some possible modifications to the base strategy:

• Select multiple ETFs within each asset class to achieve a broader holding base and to reduce tracking and management error.
• Create a more global Permanent Portfolio by including other stock and debt markets from various regions

Any modifications beyond selecting multiple ETFs that fit the requirements for each asset class will push the strategy into what Harry called a Variable Portfolio. The Variable Portfolio is where you speculate with money you can lose. More on this to come.

Why even trade in the first place?       

What lures me to the market is that it is one of the last frontiers on which merit rules and using economic means only (as opposed to political means) is sufficient to increase one’s wealth or even start from basically nothing and follow the path of  “rags to riches” if you are willing to work hard enough. No doubt there is a lot of shenanigans in the financial markets today with increasingly more obstacles being added via political action. This however does not prevent one from being a successful trader, it only adds to the difficulty. As long as the barriers to entry remain low and the markets remain at least somewhat free, there will be opportunity for profits. In fact I believe the most opportunity may lie with the independent trader in this era of increasing vertical integration within the financial industry.

Trader as Entrepreneur

One of my passions is the study of Austrian Economics (if you haven’t guessed from the title of this site) and one of the great achievements of the Austrian school is the development of the theory of entrepreneurship (¹).  It was Richard Cantillon (although not formally considered a member of the Austrian school) that introduced the concept of the entrepreneur as an uncertainty-bearer. Cantillon’s  definition of an entrepreneur as, “someone who engages in exchanges for profit; specifically, he or she is someone who exercises business judgment in the face of uncertainty … buying at a certain price and selling at an uncertain price” strikes at the essence of what it means to be an entrepreneur and makes clear the core issue facing the entrepreneur, that of uncertainty. From this definition we can establish the trader as entrepreneur, for it is the trader’s continuous task to make judgments (expressed through market participation, i.e. trading) about the uncertain future conditions of the market. Arising from this understanding and of practical importance is the question of: what are the applicable methods and tools a trader can use to make these judgments?

Methods and Tools

I plan to continue exploring the practical application of trading methods through the testing and creating of trading systems and strategies along with analysis and observations of current conditions. Most of my focus will be on technical or quantitative (in the general sense of the term) methods that can be studied and applied systematically. I plan on researching and testing conventional methods as well as introducing some of my own. Additionally I hope to investigate some of the theoretical principles of the market to see if a greater understanding is useful and can serve as a guide in making better decisions as a trader. I hope to layout and develop a “science of trading” that if for no other use puts me on the path to reestablishing myself as a successful trader.