Permanent Portfolio & Minimize Fat Tail Portfolios

I stumbled on to Permanent Portfolio (inspired by Harry Browne) over 1.5 years back. I am actually invested in this portfolio for almost an year and it has provided good returns. I worry about high gold and long term bond allocations in the portfolio but so far it has held up pretty nicely. I am not sure how it would work in the future.

In the simplest form the portfolio consists of 4 assets at 25%. These are:

1. Total Stock Market (VTI) - 25%
2. Gold (GLD or IAU) - 25%
3. Cash (can be replaced by Short Term Treasury - SHV or SHY) - 25%
4. Long Term Treasury (TLT) - 25%

If you want to learn more you can read more at http://crawlingroad.com/blog/ and follow the discussion at http://gyroscopicinvesting.com/forum/index.php.

Another strategy I am interested in is the Fat Tail minimization by Larry Swedroe. The assets in the portfolio are:

1. Small Cap Value (VBR/IWN) - 15%
2. Emerging Market (VWO/EEM) - 15%
3. Inflation Protected Treasury (TIP) - 35%
4. Short Term Treasury (SHY) - 35%

Both these strategies are expected to provide returns with low volatility. Fat Tail Minimization is equivalent to traditional 30/70 portfolio but the stock portion has relatively higher risk and bond portion has relatively lower risk (does not include corporate bonds).

Over the next few posts I will outline various flavors of the above strategy and documenting my results. Once I have described various portfolios I plan on updating the results every month.

Are Markets Efficient?

Or another way to ask the same question is: Can you get a higher return by actively investing?

Well I think, it depends :)

I guess markets are mostly efficient at least as far as an individual investors are concerned. Unless you have plenty of time to devote to markets and researching individual stocks you will find it difficult to beat the markets

If you look really hard for it then you will be able to find stocks that are under-priced and consequently make a higher return. But the question remains, does the return justify the time invested and the amount of risk you will bear to hold the position in the stock.

Image: StockCharts

Consider for an individual investor to build a diversified portfolio he should not hold more than 3 to 5% in one single stock. So that implies having around 20 to 35 stocks. This is too much work and transactions costs will be very high for the amount of money that will be invested. Investing in an index will just be easier and cheaper. If you are not diversified and hold 5 to 10% of your portfolio in 1 stock then 1 Satyam / Enron can wipe out your entire gains.

If you are high net-worth individual (HNI) or an institutional investor then you have lot more opportunities available to hedge risky stocks. You could write options, buy protective puts, delta hedge etc. These are generally used to manage risks in a well diversified portfolio and will be very expensive for a small investor.

So, if markets are reasonably efficient then what is the best strategy for an individual investor. Is it enough to just put all your money in an index fund? What other things can we do to get better returns?

Over the next several posts I will be looking into what a small investor can do.