Our Crawling Road: A Portfolio for Accumulation (part 2/2)

We think it’s a good idea to have the rock of financial independence under the feet quickly and safely, instead of going on riskier roads that might take longer than one thinks.

The portfolio we have used to reach financial independence, as certainly many have guessed, is the permanent portfolio. 

The permanent portfolio has been declared dead again and again, it's slow, archaic, contains funny assets like gold (!) and cash (!!), it's overly conservative, pessimistic, neurotic, and what-not. 

For some, this portfolio is like a monster that no-one really manages to kill off. For us, it's like the well-kept secret that made it possible for us to take the leap to the journey to financial independence.

Money doesn't care if it comes from one allocation or the other. And the portfolio, like a rusty ukrainian tractor, soldiers on with astonishing reliability. 

Even Achilles had troubles with that turtle.

(Part of painting by Francois-Leon Benouville, 1847)

The portfolio even enjoys and profits from volatility and bad weather. Antifragile, schmantifragile.

Once upon a time, a very very long time ago, like 2012 or something, there was a blog called the crawling road, by Craig Rowland.

He went deep into the details, and has written a good book on the Permanent Portfolio. It's written with a US perspective, but we still recommend it, and we hope this can illuminate some of the ideas and also the global appeal of this asset allocation. 

The asset classes in the permanent portfolio are:

• Gold
• Cash
• Stocks
• Bonds 

The basic, radically counter-intuitive yet surprisingly simple idea of the permanent portfolio is to put together four asset classes that behave differently from each other. 

As Fortune sails with her horn of plenty on the seas of the world economy, these asset classes perform differently, and as one is doing poorly, another asset class will be in the limelight.

We needed time to think it through and understand some of the portfolios intricacies. Slowly some of the beauty dawned upon us. 

Gold & Bonds

Gold was hard for us to grasp in the beginning. But let's not be fooled that one asset is necessarily better than another. 

Since we started, gold has performed exactly as well as US stocks. We would never have believed that when we started.

Bouillon can still beat the stock market.
Gold coin Septimius Severus, AD 193-211.

Euro bonds are not far behind either. 

Long-term bonds are a strange animal that do not behave as the treasury pleases.

But frankly, cash? 

Cash, as an asset, is a game of perspectives. 

Cash can grow explosively with several 100 percent over a few months or half a year. 

Of course the newspapers don't call it growth when it comes to cash. They look on the stocks, and call it a crash instead. Fear gets more clicks.

Seing big happy headlines about the sudden increase in purchase power of anyone with money in the savings account is unusual, to say the least. So we were not used to the opposite perspective. We had to learn to look on cash the other way around. 

During a year, the same amount of cash can allow us to buy 2-3 or 5 times as much of another asset class, most  notoriously stocks. 

And sometimes all other asset classes will, for a short period of time, be on sales by a factor of 2, 5 or even 7 or 8.

There's a reason why it is called a credit crunch. It's all about the perspective. 

Truly: let's not assume what tomorrow brings

Why so much of each asset class? Well, first each asset class needs to carry the weight of the portfolio when that asset is going well. A 1/4 allocation on each asset class means that there is enough weight to carry the portfolio at all times. And the other thing is to truly embrace that we do not know about tomorrow. Then it’s a good strategy to be roughly agnostic about what the future will bring, and bet equally on what will happen tomorrow. 

For us, the best comparison is perhaps with some kind of strange type of noise reduction. If one adds uncorrelated time series on top of each other, one is very likely to decrease the amplitude (volatility) of the time series. 

Less noise, more signal.

How to do it

We've set up our permanent portfolio according to the following, using standard mutual funds and ETF:s.

• Stocks 25% (8% US Large Cap, 9% Domestic Total Stock Market, 8% Domestic Small Cap)
• Long Term Bonds 25% (8% US Treasury, 17% Euro Government Bonds, all 25 years+ to maturity)
• Cash 25% (treasury bills, bank accounts and short term max 3 months fixed income, all in local currency)
• Gold 25% (several Gold ETF:s with physical gold that tracks the gold price 1-1)

As you see we've chosen to have US and EURO exposure in all variants of our portfolio, but that can easily be tweaked, even if we found, surprisingly, that increasing exposure to exchange rates in roughly these proportions actually, and very counterintuitively, increases safety and returns.

This is a portfolio that thrives on volatility.

Rebalancing

The last thing to mention with the permanent portfolio is rebalancing. 

Rebalancing the permanent portfolio means that we always have something the market wants that we can sell. Oh, the market is short on cash? We've got cash aplenty. Valuations of stocks are high? Let us buy some of that sweet gold that the market has forgotten to value. And on it goes, selling on high and buying on lows, between the asset classes, every year.

We rebalance back to the 25-25-25-25 allocation split if things get more than 10 percent units off, or otherwise annually and that's also when we invest the cash we accumulated during the year. 

This strange mix was our secret sauce, the well-kept  brew that would safely yet quickly and in as many scenarios as possible bring us to financial independence. 

Let's sum up

The permanent portfolio, we felt, had the ...

1) ... potential to protect us from the really bad scenarios and 

2) ... help us achieve financial independence also in a bleak scenario, while 

3) ... doing just as good as classic portfolios during average times.

That was our sweet spot to bring us to financial independence.

Our Crawling Road

Lucilius has achieved financial independence with exactly this portfolio. By the whims of Fortune it took the same time as it would have done if we went for a broad stock market portfolio. 

But that was just luck, which perhaps also illustrates why one shouldn’t rely on an average scenario when making a decision. And even being 6-12 or even 18 months behind the stock market would be a price he would be willing to pay to lessen the risk of a really bad or bleak scenario. 

The annual average return, including inflation ťhis time, was almost spot on the average expected return of 8 percent during that period.

Antinous is now half-way there.

We wanted to show our thinking behind this lesser-known and very conservative option. We think the permanent portfolio has merit, especially if one discovers financial independence a few years into one's working-life, and finds oneself with some money, motivation to aim for financial independence with a combination of safety and speed, but without a strategy that seemed to give a fair price for ones appetite for risk.

This was our crawling road to financial independence, and, dear reader, this is what works for us, and what we did. 

Something else might work for you.

Take care!

//antinous&lucilius

Where to go now?

• If you haven't read our reasoning why we went with a permanent portfolio during our accumulation phase, then read the beginning of this two-part article here: A well-kept secret: A Portfolio for Accumulation (part 1/2)
• Since 2019, we have made some changes to our portfolio, and given it a new nick-name: The Pathfinder Portfolio.

A well-kept secret: A Portfolio for Accumulation (part 1/2)

This is a long article. So get comfy, get something drinkable (wine!) and eatable (grapes!), and let's go back in time when we first stumbled on investing.

We already had some money saved, because saving sat well with us. We also had some not unfounded mistrust of our own ability to deal with bad times. 

If we were going to invest, it needed to be conservative and idiot-proof. 

Then we found something. At the time, it felt like one of the most well-kept secrets in the financial world. Kind of still does, actually.

Let us explain what we found.

Fortune, ever waxing and waning. We didn't trust this girl to mess too much with the money we had saved.

The Bad Scenario 
What did we do?

As Seneca might recommend, let's start by considering the doomsday scenarios. 

Much of this will be about feelings. It might be easy to laugh at us for being afraid of what we might do in a bad scenario. But, well, I'm not sure if we were cut out for the worst scenarios in the stock market. I'm still not sure we are. 

We were also well aware that the lowest depth we knew didn't have to be the lowest depth there will be; so we already knew that a future bad scenario could be much worse than what history has presented us with so far. And over a lifetime, some really bad scenarios are likely to play out.

The last half-century, the worst year (year - not period, that's much worse) for the US total stock market, including dividends, was down 49% and it took 11 years before it had crawled back to its starting point. 

We hoped to achieve some kind of basic financial independence within 5-7 years. If that suddenly turned out to be 11-15 years, that would not have felt good at all.

There's a limited number of decades to a life.

Even the classic 60/40 portfolio is quite scary too, with a 34% loss over the worst year, and it took a frightening long 11 years to come back to where the portfolio started.

Even with a bleak, but not the worst, three year run in the US, the 60/40 portfolio fares a 0.1%  In other countries, it looks worse. In Switzerland for instance, it fares -8%, in Germany and France around -7% and in Australia -5% during those same bleak scenarios.

Moving 5 percent backwards every year for three years. Ouch. 

This was why we were hesitant. We feared a major setback could turn into psychological depression and derail us entirely from the idea of financial freedom. We were just too scared, and the only advice seemed to be something like 'buckle-up, shut up, sit it through and get over it'.

The idea, according to all we read, was to bind oneself to the mast, put wax in the ears and promise oneself not to be upset about the portfolio valuation, in the case of a  stock market meltdown - with impacts for periods up to ten years. And if course, by ignoring the bad weather, one can theoretically sail through the worst of financial storms. 

Which certainly seemed to have worked for Odysseus. No listening to the Sirene's calls of selling on a bad moment there. So if you are more like Odysseus - go for it!

Greek heroes have no trouble with stock market investing.
(painting on vase, 495 BC)

As new financial sailors we didn't even know how to bind ourselves to the mast. 

Something made us queasy, with both the advice to go all-in on the stock market and with the 60/40-portfolio. We had a nagging feeling that there were more stocks in the portfolio than we could swallow. 

What could we do? And can one really decide on a strategy based on the worst scenario?

Our portfolio in a bad scenario

Well, we did find something. In the worst scenarios around the world, the portfolio we settled for dropped around 10-16 percent in the worst year, depending on the country, and it recovered completely within five years. 

So depending on how we looked on it, it was between double to five times better than stock-heavy portfolios when a really bad storm hit. 

It would still be a very rough ride, but somehow it felt like we didn’t have to hope that we were heros.

It seemed that we had found a strategy that might not entirely sink the boat if the captains were more nervous than they hoped.

The Bleak Scenario
We realized that for us, it was important to balance the objective of getting to financial independence BOTH quickly AND safely, at the same time. So one important factor was that the portfolio needed to fare decently in the short run. And the other factor would be safety. 

The worst case must still be better than a complete disaster where plans need to be abandoned.

But it was not only that. Even if things didn't turn out rosey, we did not want even a bleak scenario to become a several years long setback on our journey to financial independence. 

So we also needed to study bleak scenarios. 

But what is a bleak scenario? 

Let’s meditate. Would we be very concerned if things turned out bad in a year? No, not really, as long as things recovered within the near future. Two years moving backwards also seemed fine. But three years of going backwards, that seemed to start to nag on our journey. 

So in a three year period, we would like to have something that with some significant likelihood would at least keep pace with inflation. 

What’s a high likelihood? Well, if this was a board game, we would say that 85% would be pretty safe. So we guessed we could find a portfolio composition that would work decently in 85% of the 3-year periods in the last 50 years, in most countries. Then we would be on to something.  

If we do the same back-tracking with the portfolio we finally settled for, it fares around 1-2 percent up compared with inflation - remember, in still a very bleak scenarios where corresponding stock-heavy portfolios would go backwards - for a whole set of countries: US, Australia, Switzerland, Sweden, Germany and France.

This was a portfolio that seemed to be able to bring us to a safe harbour without major delays, even if the three years ahead of us would turn out to be not-that-good-at-all. 

The Average Scenario 
We understood that we needed to pay something to give us the protection we wanted. And one thing that we needed to pay with would obviously be the average return. 

And what is a decent return, anyway?

Would the average return be too low for our objective of reaching financial independence quickly and safely?

Using the same 50-year historical period and the US stock market as illustration, the historical average return - excluding inflation  - was 5.9% for our portfolio, 6.1% for the 60/40 portfolio and the total stock market was on average 8%. 

The averages are more similar across countries.

So on average, we were talking about 6 months to a year longer to reach independence, but with much better protection against bad scenarios.

This was the well-kept secret that allowed us to start investing for real.

Conclusions

Let's sum this up in a gigantic table. The table to rule them all. And let's colour everything that feels close to ruin and a big risk of derailing us from our journey to financial independence in red.

Summing it up for the tables-lovers out there.

Portfolio	Portfolio	US	Germany	Sweden	France	Australia
Total Stock Market	Average	+8.3%	+7.6%	+11.9%	+8.2%	+6.3%
	Bleak 3 Year Baseline	-2.1%	-5.1%	-4.2%	-8.4%	-5.7%
	Worst 3 Year Period	-16.8%	-23.9%	-23.3%	-17.7%	-21.2%
	Worst Doomsday Year	-49%	-56%	-55%	-50%	-68%
	Time to recover	13y	13.5y	11y	15y+	15y+
	Worst Time to Financial Independence	13.5y	14.5y	12y	15y	19y
60/40	Average	+6.3%	+6.2%	+8.6%	+6.6%	+5.2%
	Bleak 3 Year Baseline	+0.1%	-1.8%	-2.3%	-3.6%	-0.4%
	Worst 3 Year Period	-10.7%	-11.8%	-11.7%	-9.2%	-16.7%
	Worst Doomsday Year	-34%	-31%	-31%	-34%	-53%
	Time to recover	12y	12y	12y	14y	15y+
	Worst Time to Financial Independence	13y	13y	12y	15y	17y
Our Portfolio	Average	+5.2%	+4.8%	+6.0%	+4.8%	+4.5%
	Bleak 3 Year Baseline	+1.6%	+1.8%	+0.2%	+1.1%	+1.2%
	Worst 3 Year Period	-0.4%	-3.0%	-3.9%	-3.3%	-3.8%
	Worst Doomsday  Year	-14%	-9%	-12%	-13%	-16%
	Time to recover	5y	4y	5y	5y	8y
	Worst Time to Financial Independence	9y	10y	8y	9y	10y

Some notes: All % are yearly CAGR without inflation. So in the worst 3 years run one would experience on average a yearly setback of around -8-10% with the 60/40 portfolio, for instance. Worst Time To Financial Independence assumes that 10y expenses are already saved, which is roughly where we started, and a 50% savings rate. And we assume that up to a 16% setback in one single year is livable.

So to sum it up. If the average return was roughly the same as 60/40, but we had found a strategy that would get through a bleak or doomsday scenario relatively unharmed - why go for something else?

Yes, we would lose out on upside opportunities. But that felt like an easy trade-off if that meant we could avoid the trapdoors that risked to set us back for many years, perhaps even as long as half a decade.

Now it felt that we were on to something. A conservative trade-off between safety and return that would bring us with an overwhelming certainty to financial independence in surprisingly few years, even in a bad scenario.

This was the hidden treasure, the reasonable balance between risk and return, that no-one had told us about.

We hope that gave you some food for thought on how to think about your own journey.

In the next article we'll dive into our thoughts on the strategy we went for.

Take care,

//antinous&lucilius

Where to go from here?

• Read about how we actually set up our portfolio here: Our Crawling Road: A Portfolio for Accumulation (part 2/2).
• How did our portfolio do during the plunge in 2020? Our Portfolio During Tumultuous Times. 

NB:

Some technical details: The numbers are without inflation, so for most market one needs to add 2-3% to get a sense of what is reported as return on an investment account. And as we said before, dividends are also assumed to be reinvested for both stocks and bonds.

We have back-tested this ourselves, and used Monte Carlo simulation (both simulators available on the net and home-built simulators). The numbers in the article  stretches back to 1970 and comes from portfoliocharts.com. If you haven't been there, go there. We love it.

Why look at so many countries? Well, it increases our feeling of safety that it's not a local fluke for one country that our portfolio worked well, but only there. In the short run, there seems to be much more of a fluke with the performance of the 60/40 portfolio.

Another remark: A big, big risk with looking at historical numbers is that one adapts a portfolio that fits the history, rather than one that fits the future. But if one finds a portfolio that works decently irregardless of where in the world it's implemented, it starts to actually say something about the robustness of that portfolio.