“The key to success for everything in business, science and technology is never to follow the others.”Masaru Ibuka, co-founder of Sony
There’s a lot of fear, uncertainty, and doubt going around concerning investing and the financial markets right now. Instead of panicking, it’s important to take this opportunity to re-evaluate your current long-term investment strategy to find ways to improve.
In that spirit, I’m going to share with you how I personally manage my long-term investment funds. You certainly don’t have to do what I do, but I’ve put a lot of effort and research into my preferred strategy, which includes many features explicitly designed to make long-term investing psychologically easier. I hope you find it useful.
This should be obvious, but laws vary around the world and change month-to-month, so I want to make sure there’s absolutely no misunderstanding before I begin.
Here’s the short summary: I’m providing information about how I personally choose to invest my money. What you choose to do with this information is completely up to you, and the consequences of your choices are 100% your sole responsibility.
I’m not a lawyer, accountant, registered financial advisor, broker, or securities dealer. I don’t even play one on TV. This post is for informational purposes only and does not constitute an offer or solicitation to buy or sell any security discussed herein or in any jurisdiction where such would be prohibited. (That’s for my SEC attorney readers.)
All investments contain elements of risk. You should understand what these risks are before buying any investment. Past performance is no guarantee of future results. Any opinions, news, research, analyses, prices, or other information contained in this post is provided as general market commentary, and does not constitute investment advice. (That’s common sense.)
Now that we’re clear, let’s get started…
Preferred Account: SEP-IRA
Since I’m self-employed, I manage my own long-term investment / retirement funds. The account I use to do this is a SEP-IRA, which stands for “Simplified Employee Pension Individual Retirement Account.”
I always contribute the maximum I’m able to contribute to my SEP each tax year. Under US Tax rules as I write this, I can contribute up to 20% of my income before my self-employment tax deduction, up to a maximum of $49,000. The contributions I make are deducted from my taxable income, which is good, since that means I have more capital in my account that can grow for decades. When I begin taking the money out later (after I turn 59 1/2), it’ll be taxed as normal income.
Preferred Strategy: Harry Browne’s “Permanent Portfolio”
I use a Permanent Portfolio allocation for 100% of my long-term investment dollars. This allocation, which is unique in many ways, is described in Harry Browne’s Fail-Safe Investing.
Here’s the asset allocation:
- 25% Total Stock Market Index - via the Vanguard Total Stock Market ETF (Ticker: VTI)
- 25% Long-Term Government Bonds - via the iShares Barclays 20+ Year US Treasury Bond ETF (Ticker: TLT)
- 25% Gold - via Central Gold-Trust, which holds gold bullion (Ticker: GTU)
- 25% Cash - via the iShares Lehman 1-3 Year US Treasury Bond ETF (Ticker: SHY)
There are several reasons I prefer a Permanent Portfolio allocation:
1. The Permanent Portfolio requires zero prediction.
No one can predict the future. Period. Promises to predict the future are endemic in investing, and result in large losses and poor investment decisions.
The Permanent Portfolio asset allocation doesn’t try to predict anything - it simply recognizes that financial markets will continue to change. Some asset classes will do well, and others will do poorly.
Instead of attempting to predict which asset classes will outperform, it holds four negatively correlated basic asset types, which counterbalance each other. On the whole, the portfolio grows as well as (or better than) the total stock market, without huge swings in volatility, which are psychologically challenging to handle. (See #3.)
2. The Permanent Portfolio performs extremely well.
The compound annual growth rate from 1972-2008 was 9.7%“:http://crawlingroad.com/blog/2008/12/22/permanent-portfolio-historical-returns/. The portfolio returned”7.8% in 2009, and “*14.5% in 2010":http://crawlingroad.com/blog/2010/12/31/permanent-portfolio-2010-results/.
Here’s a graph of the past ten years of Permanent Portfolio returns, compared to an S&P 500 Index, including dividends:
That’s a better return without the volatility - note the two 30%* nosedives the S&P 500 index has taken over the past ten years. That’s not a recipe for sleeping well at night. There’s no guarantee the market won’t do that as you’re preparing to retire, either.
The Permanent Portfolio was largely unaffected, and in some cases grew, as the stock market was declining. That’s very cool.
3. The Permanent Portfolio largely eliminates Loss Aversion.
Humans universally hate to lose - they even hate the potential or perception of loss, however transitory that loss actually is. This phenomenon is called”Loss Aversion“:http://book.personalmba.com/loss-aversion/, and it explains why people”buy high, and sell low" instead of the reverse.
You can think of the Permanent Portfolio as being the four major asset classes that people either excitedly acquire when times are good or flee to when things get scary. When business is good, everyone is enthusiastic about stocks. When inflation, deflation, or recession are looming, investors flee stocks into Bonds, Gold, or Cash. By owning all four asset classes, your returns are stable, regardless of the whims of the market.
When most 100% stock investors experienced a loss of (~~40-60%) in 2008, the Permanent Portfolio gained +1.8%. The largest single yearly loss the Permanent Portfolio has experienced was in 1981.
I’ll take market returns without the market volatility any day: it frees my time and attention for more important matters, like building my business.
4. The Permanent Portfolio is very, very inexpensive.
You’ll note that all four asset classes are available as low-cost ETFs, which stands for “Exchange Traded Fund”. These are automated funds that are run using strict rules about what they contain.
Since these funds are managed by computers automatically, I don’t have to pay a wealth management advisor 2-3% of my assets every year to perform worse than the market. Instead, I pay an absurdly low fee to get better results.
In addition, there are only four assets to rebalance, so my transaction fees are extremely low as well: no active trading is required.
5. The Permanent Portfolio doesn’t rely on human decision-making.
The Permanent Portfolio is designed as a system that largely eliminates decision-making. The only actions required are: depositing money into the account, allocating the funds in the 25% chunks described above, and rebalancing the portfolio to when any one of these assets make up 30-35% of the portfolio, restoring the initial 25% allocations.
The systematic nature of the portfolio means I don’t have to make decisions on what to invest in, when to invest, or try to predict future prices. I simply run the system. And I can do all of these things by myself, instead of paying someone to do it for me.
5. The Permanent Portfolio can be fully automated.
I recently transferred my account to a firm called FolioInvesting.com. I switched for a simple reason: to my knowledge, Folio Investing is the only online brokerage that has extremely robust automation and rebalancing features.
When you open an account, Folio Investing allows you to create “Folios” with specific asset allocations. I only have one folio, which is set up using the Permanent Portfolio allocation described above.
Every month, all it takes to rebalance the portfolio is a single operation: clicking the “rebalance” button. The platform takes care of the rest. You can even set the system to rebalance regularly, on a schedule you specify.
This is a brilliant use of Guiding Structure. By automating the system, I don’t have to risk Willpower Depletion and prediction-related discomfort when rebalancing, the way I would by selling a high-performing asset to purchase a low-performing asset. I’ve decided what I want to do in advance, so the platform lets me do it automatically.
The automation features remove Friction from my investing process. I can deposit money automatically, allocate money automatically, and rebalance automatically.
All of these things remove barriers to successful long-term investing, making it much more likely I’ll do well over the long term.
There you have it: a simple, inexpensive, easy, systematized, automated way to reap the rewards of long-term investing. I hope you find it useful.