How to diversify your portfolio to avoid market risks (3/20)

We will first start by looking at the approach used by Harry Browne, inventor of the famous Permanent Portfolio, before looking at other strategies. His idea is that in every type of economic cycle, there is a type of asset that manages to come out on top.

The Permanent Portfolio is a bit like the stock market what the all-season tire is to the car. It allows you to generate profits in almost any situation, which means practically absolute profitability and low volatility.

According to H. Browne, each economic season has its "means of survival":

- growth: owning shares

- recession: having cash

- inflation: owning precious metals

- deflation: owning bonds

Browne recommends placing 1/4 of your assets in each of these assets and rebalancing when a category exceeds 35% or falls below 15%. Or even simpler: rebalancing once a year. And that's it!

The Permanent Portfolio has proven itself since in 40 years it has only had 4 negative years. Frankly, for such a simple and inexpensive approach, it is an achievement.

This would give a return close to 10%, which is practically the same as stocks, with a relative standard deviation of only 7.5%, or more than half compared to the market. However, other backtests give lower returns, ranging from 5 to 8%, which is still not so bad given the low volatility and the few negative years.

In order to implement this strategy, one can strictly adhere to the principles of the Permanent Portfolio. This is certainly the simplest and “laziest” way to put it into practice. The rules are clear: 25% in stocks, 25% in gold, 25% in long-term bonds and 25% in cash (or very short-term bonds).

This allocation is permanent, as the name of the portfolio indicates. You just have to rebalance the positions once a year so that each type of asset keeps the same proportion. The simplest thing is to limit yourself to 4 ETFs, 1 per type of asset, and that's it. This is ultra-passive management! We will see later which ETFs can do the trick, and what the limits of the system may be.