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Implementing my Permanent Portfolio

Asset Allocation, Strategies

Written by:

Alvin Chow

Long time readers would know that I have been investing in STI ETF on a monthly basis. It has been doing well for me (not bothered about the ups and downs of the market and yet I can make decent returns). I have taken a new direction to for my investment portfolio after gleaning more insights on the importance of investing with ‘size’ and being protected against any economic scenario.

Being right with size

When I interviewed Tom Yuen, he said the difference between top traders and average traders is the guts to trade with big size, and I quote from Secrets of Singapore Trading Gurus, “The best trader would know when to go in with size and dare to take the plunge. Having the right call is not enough. You have to make the right call with the right size.”

And Dennis Ng often mentioned that it would be difficult for traders to earn multiples of their capital because of positioning sizing. At any one time, a trader would probably risk no more than 2% of their trading capital in one trade, and hence, he cannot earn a large profit even though he is right.

Both of them made sense to me and I had the following conclusion – Trading is a job earning a stream of income and it is not a way to grow wealth (for most people). When your trading capital becomes too large, you would not be comfortable risking the same percentage of your capital into one position. For example, risking 2% of $100,000 is $2,000; while risking 2% of $1,000,000 is $20,000. Would your psychology remains stable if you are managing the trade that can possibly lose you $20,000? Most of us do not have the genetic makeup to make such big trades. Hence, limiting risk would correspondingly limit returns. You should trade if you want to pursue it as a career. But what if you can only trade $1m worth of capital and you have $2m? Where would you put your additional $1m (many would say properties. I would come to that later)?

I hope that at this point we have establish an understanding that I am not trying to recommend people to stop trading, but I want to emphasize it is a career choice and at the end of the day, it is still about earning an income. You have to agree with me that you will still need an investment portfolio no matter if you trade or not. In fact, most people fail to pay enough attention to their total investment portfolio. As long as you have excess capital, you need to know how to grow them properly.

Returns is highly dependent on asset allocation

Academics and investing professionals have been hauling criticisms at each other. Academics would rate the fund managers’ stock selections equivalent to (or worse than) monkeys throwing darts on a list of stocks. And investing professionals will argue that talk is cheap and the academics did not have enough practical results in investing to prove their theories.

I think for myself and judge objectively. I would tend to agree that the concept of asset allocation that the academics has preached. They said that asset allocation (the composition and proportion of financial assets in you investment portfolio) accounts for 80% of the returns. However, “asset allocation” has become a cliche as it has been over used or even abused by many fund management and insurance companies in order to sell their funds at high costs.

Traditionally, only stocks, bonds and deposits are considered financial assets that make up the portfolio. Real estate and precious metals are alternative assets but are equally important to your portfolio. In general, most people would have a higher proportion to stocks as they believe stocks will be the main source of growth for their capital. This is not wrong but we have seen many equity heavy portfolio, including the famous Yale Endowment Fund performed badly in the 2008 financial crisis. Quoted from “Invisible Hands”,

“Yale University saw its endowment assets fall from almost $23 billion to $16.3 billion for fiscal year 2008-2009, a decline of almost 30 percent….”

and “Harvard University saw its endowment assets decline from a peak of $36.9 billion to $26 billion over the same period, also a decline of almost 30 percent.”

Despite that, Yale Endowment fund was still able to grow at an average annual return of 14.2% for 20 years up to 2011. This shows the power of proper asset allocation. A good asset allocation allows you to tolerate a draw down on your capital that is acceptable to you, while growing your wealth over the long term.

Picking stocks is tactical; Structuring portfolio is strategic

Remember I mentioned in the previous point, you will limit your profit as long as you limit the size in each position. When you pick a basket of stocks, the returns from one stock is not going to have a big influence to your net worth.  It is designed that way because that is how one reduces risk – you diversify and not put all your money in one stock in case you are wrong. You can continue to pick stocks and optimise your equity component in your portfolio, but what about other asset classes like bonds, real estate and precious metals? Are you prepared for economic scenarios where stock market is performing badly?

Picking stocks is just about winning battles. Structuring your portfolio is about winning the war. You can lose battles but you cannot afford to lose the war.

The future is not predictable – need to be prepared for all financial scenarios

Nobody can predict the future accurately. So your portfolio at any one time, must have one or two assets that will perform well in any economic scenario. There are four kinds of economic scenarios that you need to protect your wealth:

  • Prosperity – economy growing, favors stocks
  • Inflation – consumer prices rising, favors gold or real estate
  • Tight money or recession – money supply insufficient, people have less cash and leads to recession. Favors cash.
  • Deflation – Opposite of inflation and according to history, sometimes triggered a depression. Interest rates fall, favors bonds.

Dennis Ng always talk about the investment clock invented by Trevor Graham where economy moves through these cycles, just like we go through the year in four seasons. There will always be one asset class that perform well in one of the economic scenario. Likewise, you must build a portfolio that have all four components. You cannot say you are a real estate investor and you only want to buy properties. Because now is the inflationary period and commodities have been doing well. There are three other seasons that you need to go through which many people do not pay attention to. Most retail investors are herd animals, they will always chase after the asset class that is hot right now and it always prove to be too late. If you have a portfolio done properly, you will be selling the asset that has risen in value and buy the assets that have dropped in value. Only in this way you can buy low and sell high.

Timing the market and Time in the Market

Because we cannot predict the future, we do not when to move from one asset class to another. There is a price if you miss out those days where market moves the most. Kenneth Fisher did a research in S&P 500 performance from 1 Jan 1982 to 31 Dec 2005 where the average annual return was 10.6%. But if you miss:

  • 10 of the 6261 trading days, your average annual return drops to 8.1%
  • 20 of the 6261 trading days, your average annual return drops to 6.2%
  • 30 of the 6261 trading days, your average annual return drops to 4.6%
  • 40 of the 6261 trading days, your average annual return drops to 3.1%
  • 50 of the 6261 trading days, your average annual return drops to 1.8%

Hence, you should not sell out any asset class in your portfolio. You should time the market by selling what is expensive and has taken up a larger percentage of your portfolio than your desired proportion, and channel the profits to the asset that is under-performing. This is the timing that you should do and always have sufficient exposure to the market at all time. Again, back to point one: always be right with size, you do not want to miss those major market moves.

How I implemented my permanent portfolio?

After reading many types of portfolio structuring, I found that Harry Browne makes most sense with his permanent portfolio concept. Since we do not know what the future may be, we will just divide the capital equally into 4 parts:

  • Stocks
  • Bonds
  • Cash
  • Gold

For simplicity, I bought into 3 low cost ETFs and held my cash component with my broker

  • 25% – Vanguard World Stock ETF (VT)
  • 25% – iShares Barclays 20+ Years Treasury Bond Fund (TLT)
  • 25% – iShares Gold Trust (IAU)
  • 25% – Phillip Money Market Fund

I chose VT because it is one of the cheapest ETF to invest in a global stock market. The reason why I diversify globally is because no country can consistently give the best returns over the years and no one can predict who is going to outperform next.

I chose 20 year US treasury for my bond component because there is lack of a better choice. I would have bought a long term international government bonds ETF but there isn’t one in the market. There are international corporate bond ETFs but I prefer to stick to government bonds for better stability. As for duration of bonds, I prefer longer term bonds as they are more volatile than shorter  term bonds – I will have more chances to buy low and sell high.

I chose iShares Gold ETF instead of the popular SPDR Gold because the former charges only 0.22% as compared to the latter’s 0.4%.

Lastly, I opted for the Phillip Cash Management Account which they will automatically invest in the Phillip Money Market Fund for any free cash I hold with the brokerage. This gives me the flexibility to buy into any of the three ETFs any time I need to. I would not have this flexibility if I put my money in fixed deposits which get locked in for a few years.

When do I re-balance my portfolio?

I plan to re-balance my portfolio at least once a year. I will also buy if any asset falls to 20% of the portfolio and sell any asset that has risen to 30% of the portfolio. By maintaining the portfolio composition, I will always buy low and sell high.

How to implement your own permanent portfolio?

You can continue to pick stocks if you like. But that will only make up your equity component in your portfolio. Likewise, you can count properties (not the one that you are staying) as the commodity component in your investment portfolio. There are many ways to structure your portfolio and I will suggest you start studying the various compositions and how they fare in their returns and draw downs.

19 thoughts on “Implementing my Permanent Portfolio”

  1. You said “Academics and investing professionals have been hauling criticisms at each other”. Listen to the one who make the most money.

    Reply
  2. Hi Alvin,

    Thank you for your article. I have learnt a lot. I am curious : will you still keep your STI ETF that you invest monthly ?

    I am considering doing the same.

    Thank you

    Regards
    Phyllis

    Reply
  3. Hi Jon,

    thank you for the informative article. I am also a believer of permanent portfolio just like you. Anyway, do you hedge your foreign exchange risk since most of your holdings are denominated in the USD – 75%.

    Reply
    • At the moment, I do not hedge the currency risk. But indeed it is something that I am pondering. I may eventually buy treasuries from my home country instead of TLT to reduce exposure to USD

      Reply
  4. You can get all the ETFs with DBS Vickers or IG markets if you want leverage (not advisable).

    Also, I am currently doing some analysis on permanent porfolios.. and find that VT has about 93% correlation with the S&P 500, so if you are ok with that you might want to look at the VTI (Vanguard Total US Stock Market) and VOO (Vanguard S&P 500), both have a lower expense ratio (0.06% and 0.05% respectively) than VT (0.22%).

    In addition, if you are looking at the TLT, 2 other alternatives are the VGLT and the EDV, which are Vanguard bond funds as well and they have > 95% correlation with one another. Both also have lower expenses ratio than the TLT.

    Not affiliated with Vanguard, just that research leads me to the fact that Vanguard tends to have the lowest expenses ratio for its funds, and has lower tracking error probably due to its replication method.

    Also given that most of these funds are denominated in USD, it would probably make sense to hedge the currency exposure by shorting some USDSGD.

    Just my two cents. Invest safely.

    Cheers!

    Reply
  5. Hi,

    I would like to share my implementation of Singapore version of Permanent Portfolio:

    What is in my Singapore Permanent Portfolio?
    25% Stocks: Singapore STI ETF. SGX symbol: ES3. Use online DBS Vickers Cash-upfront brokerage account to buy in SGX due to lowest commission. No foreign currency exposure hence no need to currency hedge.

    25% Long-term Government Bonds: Singapore Government 30 Year Bond. SGX symbol: PH1S. Use online UOB Kay Hian brokerage to buy in SGX due to mroe reasonable bidding range. DBSV’s online bond bidding range is too unreasonably restrictive! Try bargain for a good price as this bond is less liquid. By local law the local market makers will always have to quote bid/ask price for SGS bonds in the market so you will have someone to buy/sell from. So far after 3 months PH1S is working as intended in this portfolio – it has risen at least 10 percent and has overtaken losses in other assets. No foreign currency exposure hence no need currency hedge. Coupon Payment Dates 01 April and 01 October.

    25% Gold: UOB Gold Savings Account. No commission. Personally go to any UOB branch counter to deposit and withdraw gold – not a big issue since deposit gold at most once a year. No storage issues. Whatever currency you buy gold in, you do not need to currency hedge on gold! You can track gold price in Singapore dollars using Yahoo! Finance ticker XAUSGD=X .

    25% Cash: Currently holding cash portion in bank savings account. Current return in Money Market is so low that I do not trouble myself to move my cash. Liquid cash in bank is nicer for me right now. Alternative place to hold cash for some returns is fixed deposit, and Singapore Government 3-Month Treasury Bill.

    This is half a page of my insights. I have 4 more pages of insights on my Singapore Permanent Portfolio. If anyone is interested to read I shall post them.

    Reply
    • Hi SH, interested to find out more about your Singapore Permanent Portfolio.
      Why do you say you do not need to currency hedge on gold? As it is a Singapore based portfolio, you would want your returns to be in absolute SGD. If you were to buy gold in USD, and USD strengthens, eventual conversion back to SGD will see the gold portion returning less than it ought to. If you are buying gold in SGD I could understand a little better, but even so, you are just building in the currency risk and not eliminating it.
      Pls do share. Thanks!

      Reply
      • Jon,

        I’m setting something up similar for Canada, and I think the reason you don’t want to hedge gold is that its role in the PP comes in when your local currency devalues against the world (as in the case of Iceland). Had you hedged the USD/SGD, then if the USD remains intact but the SGD devalues, you just lost your protection. In other words, you would bring in currency risk if you actually hedged it – an ironic play on words.

        Reply
  6. Hi Alvin,

    Glad that you introduce permanent portfolio as another source of investment.

    I wonder is there any reason why to set sell any asset in the pp if gain more than 30%, and buy any asset if price drop for more than 20% ? e.g. why must be 30% and not 40 or 50% if the asset is trending up ?

    Or another approach mention is that to adjust the pp to all assets 25% each, say rebalance twice per year.

    Which approach is more time proven ?

    Thanks.

    Reply
    • Hi meng, the original concept is to sell an asset class to 25% when it hits 35%. I shd have updated the post. Sorry for the error. This is to allow the asset class to run for a while. Why not 40 or 50 I am not sure. Probably it will nv reach there. 35 seems to be optimal and it is not as regular as it seems. Maybe once a few years u get to rebalance.

      Reply
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  8. Hi Alvin,
    I am new to currency hedge.
    In the midst of building a portfolio in Singapore.
    Should our permanent portfolio consists of 25% x 4 of USD components, could you kindly explain how do we currency hedge please?

    How much should we hedge?
    Do you have an article written just on SGD/USD hedge?
    What are the red flags that we should take note while hedging?

    thank you

    Reply
    • Hi Larry, if you intend to live in Singapore for retirement, it does not make sense to hold a portfolio of assets that are denominated in foreign currencies. The risk is not worthwhile. Historically, SGD has appreciated against many foreign currencies and any gain in your assets may be wiped out by the losses in currency exchange.

      Permanent Portfolio is designed for your country of residence and should have 75% in the country’s currency. Only Gold is the exception which is closely related to USD.

      Reply
  9. Hi there,

    I have been a avid reader of your blog and was inspired to build a permanent portfolio after reading it.

    Been building a steady flow of Nikko STI ETF via RSP from POSB
    Am looking to accumulate some bonds to create a 70-30% stock/bond split

    However ran into the following doubt/challenge
    Understand that bond and stock has not been moving inversely for the last few years, hence first question would be is it still wise to buy into bond etf given that they have not been moving inversely ?

    Question 2 would be
    Under current rising interest rate environment, do you think it is wise to buy into bond etf ?

    Reply
    • The purpose of building a stock-bond ETF is not to spend too much time thinking about what to buy and sell, and when.

      You have shown some interest in this area and seems like you would like to spend more time and effort managing your portfolio.
      Hesitating building the bond ETF in your portfolio makes sense given the highly anticipated interest rate hike.
      On the other hand, there are also investors who do not care about this and still do fine with a stock-bond portfolio.
      Either way is not wrong.

      More activities do not necessarily translate to higher investment returns. There is still risk choosing certain investments over the others, or timing the market.

      Reply

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