I am a strong advocate of a permanent portfolio as described in Harry Browne’s book Fail-Safe Investing.  I believe it should make up the majority of one’s investable assets outside of any real estate or business ownership aside from stocks.

The permanent portfolio is simple.  Anyone with a little financial knowledge should be able to set one up with relative ease.  It just takes a little discipline in sticking to it and occasionally rebalancing.

The portfolio consists of cash, long-term government bonds, stocks, and gold.  The four investment categories are divided up equally.  You will have approximately 25% of each.  If any one investment gets too far above or below the 25%, then you can rebalance it.

I have mentioned ways before of tweaking the portfolio.  If you are a particularly aggressive investor, you could consider reducing your cash portion and adding it to the other portions.

For example, you could put just 10% into cash, and put 30% each into stocks, bonds, and gold.  This would make it more volatile.  You would also probably get hit harder in a recession.  Of course, the lack of volatility is one of the main attractions of the permanent portfolio.

When we talk about cash, it isn’t really cash.  Most of your cash will be in a checking account or short-term debt instruments.  You might have your “cash” in a money market fund, a savings account, or even a very short-term cd.

While I have made the suggestion of possibly reducing the cash portion for aggressive investors, I do want to emphasize the importance of cash in the portfolio.

First, as I already alluded to, cash is good to have in a recessionary environment.  It provides some stability.  As the saying goes, cash is king in a recession.

Second, even though cash would be seemingly bad in an environment of high inflation, it isn’t necessarily terrible.  If you have an environment of high price inflation and high interest rates as was seen in the 1970s, then cash won’t be as bad as you might think.  The reason is that you are still earning high interest rates.  The real interest rate (as opposed to nominal) may still be slightly negative, but at least it is somewhat keeping up.  In today’s environment, you are definitely getting a real negative interest rate on short-term debt.

Third, and probably most important, is that cash is there for rebalancing in a recession.  That is one of the reasons cash is king in a recession.  You have cash to buy beaten down investments while almost everyone else is feeling broke.

If we hit a recession and stocks and gold both go down, while bonds stay about even or even go up, then you will be able to use some of your cash position to buy gold and stocks when they are down.  That is one of the big benefits of the permanent portfolio.  You are forcing yourself to buy low and sell high.

The permanent portfolio has a bias built in for higher price inflation.  Overall, I think this is positive.  You obviously need higher returns during a time when you are losing purchasing power.

The permanent portfolio has basically done nothing over the last several years in terms of returns.  We are in an environment of low interest rates, relatively low price inflation, and struggling growth.  It is not a surprise that the portfolio is not up, especially considering the major downturn in gold until recently.

I still think the permanent portfolio is the best option for the passive investor.  It is probably the best option for most non-passive investors as well.  It is designed to hold up in any economic environment.

I believe that we are likely headed into some kind of a recession.  I am not stating that here for speculative reasons, but just to confirm the importance of having 25% cash in your permanent portfolio.  The bonds are also vitally important, as interest rates could fall even further.

If stocks plunge, then you will have other assets available, such as your cash, to buy stocks when they are low.

The permanent portfolio may not seem too exciting right now, but you will be happy when stocks are plunging and your friends can’t sleep at night.  You won’t worry too much if you lose a few percentage points here and there.  And you will have cash available to buy when virtually nobody else wants to buy or nobody else has the money to do so.