Build a ‘buy-and-forget’ portfolio

If I could give just one piece of investment advice, it would be this: investing should be as simple as possible. You want a strategy that is cheap so you don't waste money on costly managers or complex products and low maintenance, so you can get on with the important things in life. This is exactly what American financial adviser Harry Browne tried to design with his Permanent Portfolio'.

Having lived through the awful environment of the 1970s, he wanted to create a portfolio that could cope with whatever the world threw at it recessions, inflation, deflation and also make decent money when times were good. He wrote about it in 2001 in his book Fail-Safe Investing: Lifelong Financial Security In 30 Minutes.

The portfolio is split into four equal parts: a quarter in US stocks, a quarter in US Treasury bonds (government debt), a quarter in cash, and a quarter in gold. By holding just those four assets, Browne reckoned that most investors could achieve their financial goals with far less worry than most other methods. An event that hits one bit of the portfolio should be good for one or more of the other parts. And because each accounts for only 25% of the portfolio, no single disaster can devastate the whole plan.

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Shares provide decent returns in good times. Bonds also tend to do fairly well when the economy is calm and growth steady. Recessions or deflation (falling prices) are bad for shares, but good for high-quality bonds and cash, because their buying power increases. Periods of high inflation, meanwhile, are bad for bonds but good for gold.

It's simple to run too. At the start of each year the portfolio is spread equally across the four asset classes. At the year-end it is rebalanced back to equal weightings (25% in each investment). So if an investment does well during the year, and ends up accounting for more than 25%, the investor takes some profit and reinvests it in an area that had performed less well. This automatically means selling high' and buying low', whereas many investors do the precise opposite, chasing rising, expensive assets and avoiding falling, cheap ones.

Much of this is now conventional wisdom. A 2012 paper from asset manager Vanguard backs up earlier studies that say that investment returns come mostly from the assets you own, rather than the shares you pick, or when you buy or sell. And spreading your money across investments that behave differently to one another (are non-correlated', in the jargon) is one of the best ways to reduce your risks. But how does it do in practice?

In their book on Browne's Permanent Portfolio, Craig Rowland and JM Lawson found that, between 1972 and 2011, it delivered annual returns of 9.5% if rebalanced each year, or 8.8% if left alone. That may not seem like a big difference. But over 39 years, the rebalanced portfolio only lost money in four years, with a maximum annual loss of just 4.9%. The other portfolio lost money in 11 years, with a maximum loss of 21.6%. I know which I'd rather own.

So how would Browne's strategy have worked for British investors? I crunched the numbers and the answer is very well indeed'. Between 1983 and 2012, the Permanent Portfolio returned 8.34% a year, compared to 12.53% for the British stock market.

You might be wondering: how is that impressive? Well, during the 30 years up to 2012, it's true you'd have made more in the stock market. However, you'd also have taken on much more risk. Indeed, the risk as measured by the standard deviation (SD how much returns bounce around their average levels) was more than three times higher for the stock market alone.

What does that mean in practical terms? Well, the Permanent Portfolio only lost money in two of the 30 years, with the biggest annual loss being 2.53% in 2001. Remember this is during a period when the British market saw epic crashes in 1987, 2001, and 2008. And between 2003 and 2012 (as shown below right), a permanent portfolio has not only involved less risk than stocks alone, but also higher returns.

Of course, short-term performance can be very variable. And so far, 2013 has been a poor year for the Permanent Portfolio. Interest rates on cash are tiny and bond and gold prices have fallen sharply. However, that rather proves the point this is a buy-and-forget' portfolio, not one to tinker with every other day.

If you'd like to set one up yourself, I have some suggestions for how to go about it.

How to follow the strategy

If you like the strategy, it is cheap and simple to set up and run. One approach for British investors is to put the 25% cash component of your money in a savings account; 25% in the Vanguard UK Equity Index Fund (a fund that tracks the UK market); 25% in the iShares UK Gilts ETF (LSE: IGLT); and 25% in the ETFS Physical Gold (LSE: PHAU) exchange-traded fund. You then forget about these investments until the end of the year, and then rebalance each back to 25% of the total portfolio value.