Survive a financial nuclear winter

The “cockroach portfolio” is as hardy as the indestructible insect it is named after, says Dominic Frisby

The cockroach portfolio
(Image credit: Getty Images)

Many investors look to gold or even bonds such as gilts to protect their portfolios of shares from volatility, but a cockroach approach might be an even better option. 

Cockroaches have been around since before the dinosaurs. They are around 320 million years old, having originated during the Carboniferous period. They are hardy as hell. They can survive in tropical heat or Arctic cold. 

They can tough out the dryness of the desert where there is no access to water, but they can also survive in and under water. They can even make it through nuclear fallout. Many survived the bombs dropped on Hiroshima in 1945. You can even cut off a cockroach’s head and it will live on, at least for a bit. 

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It would be ideal to have a portfolio as hardy. In the wake of the global financial crisis, I remember seeing a presentation by investment strategist Marc Faber in which he described a portfolio for all economic weathers. It broke down as follows: 25% gold and cash; 25% equities; 25% bonds; and 25% real estate. 

Dylan Grice, who at the time was an analyst with Société Générale, advocated something similar. He called it the “cockroach portfolio”, after that most hardy of creatures. 

Safety and profit in all environments 

The idea of a permanent, cockroach portfolio for all weathers was first popularised by American investment advisor, Harry Browne, who died in 2006. Browne was also an author and politician. His books, mostly centred around investment, sold more than two million copies, and in 1996 and 2000 he was the Libertarian Party’s presidential nominee. 

But, as an investment advisor, in 1982 he developed what is known as “the permanent portfolio” investment strategy, which he then wrote about in his 1999 book, Fail-Safe Investing: Lifelong Financial Security in 30 Minutes. This portfolio would ensure “you are financially safe, no matter what the future brings”. 

Browne’s idea was that there are four macroeconomic environments, or four seasons: inflation, deflation, growth and recession. One of those four will always apply. So his portfolio was allocated in such a way that some of it would perform well in each of those seasons. 

A quarter of the portfolio was in US stocks. They would do well in times of growth. Another 25% was allocated to long-term US Treasury bonds. These would also flourish during times of growth – and in deflation too.

The 25% devoted to cash is for recessions and the 25% in gold would see you through inflation. You would rebalance once a year to maintain those allocations. Browne’s portfolio differed from Grice and Faber’s because it contained no allocation to real estate. But there you have it: a portfolio allocation that might even make it through financial nuclear fallout, like a cockroach. 

I have two criticisms. Firstly, if you go back to 1982, when Browne first conceived this portfolio, the S&P 500 has since outperformed by some margin. Sure, the cockroach portfolio is much less volatile, but what’s the point if you can just get an S&P tracker? You could argue that this has been an extraordinary period for US equities, but even so... 

Indeed, if you want total cockroach, why not own gold and gold alone? Gold, being indestructible, is even more hardy. It’s been around a lot longer, and it lasts a lot a lot longer. When you, me, humanity and the cockroach itself are all long gone, gold will still be there shining away. The reason not to just own gold is that you want diversification.

How useful is diversification?  

Look at some of the richest people you know and I’ll bet you close to none of them made their fortune by having a diversified portfolio. They might have made their money from their profession or by building a successful business, in property, bitcoin or trading, or out of an inheritance or a divorce, maybe. Perhaps they wrote a book, a film, a play or a song that turned out to be a smash hit. Most of the time they were anything but diversified. Instead, they were concentrated. 

But if the majority of the super rich made their money being concentrated, they kept it by being diversified. The purpose of a diversified portfolio is not so much to make your fortune, but to keep and grow what you have. 

I understand that even Warren Buffett, who is the big example that counters my argument, had a few big wins early on and then grew his fortune building a successful investment business and levering what Einstein called the eighth wonder of the world (compounding) in his favour. 

I was chatting with a mining investor the other day. He made $40m in 2005. But he was moaning about the fact that he stayed concentrated and therefore handed a vast lump of it back. Had he instead diversified and then grown his wealth at, say, 10% a year ever since, he would now be sitting on a $200m fortune. 

Concentration is how you make your fortune. Diversification is how you keep and grow it. Unfortunately, concentration is also how you can lose a fortune. 

Let’s say you went all in on bitcoin in 2013. Or technology. You’d be minted. 

But if you went all in on mining in 2013, you’d be skint.

Dominic Frisby

Dominic Frisby (“mercurially witty” – the Spectator) is the world’s only financial writer and comedian. He is MoneyWeek’s main commentator on gold, commodities, currencies and cryptocurrencies. He is the author of the books Bitcoin: the Future of Money? and Life After The State. He also co-wrote the documentary Four Horsemen, and presents the chat show, Stuff That Interests Me.

His show 2016 Let’s Talk About Tax was a huge hit at the Edinburgh Festival and Penguin Random House have since commissioned him to write a book on the subject – Daylight Robbery – the past, present and future of tax will be published later this year. His 2018 Edinburgh Festival show, Dominic Frisby's Financial Gameshow, won rave reviews. Dominic was educated at St Paul's School, Manchester University and the Webber-Douglas Academy Of Dramatic Art.

You can follow him on Twitter @dominicfrisby