March 21, 2012: Implicit Prosperity Tilt

The Permanent Portfolio’s (PP’s) equal split between stocks, 30 year Treasuries, gold, and T-Bills is very close to being economically neutral. The portfolio’s returns do vary from year to year, but to connect them with any specific economic outcome is difficult. This economic neutrality is driven by asset classes that respond differently to various economic outcomes, resulting in strong diversification benefits and a slow upward drift in portfolio value.

Some economic optimists can appreciate the careful balance of asset classes, but still desire to tinker with the PP by boosting the stock allocation in hopes of juicing up the long-run returns of the portfolio. This logic stems from the belief that in the long-run capitalism promotes economic growth and prosperity. Thus, given a long enough time frame, everything will work out swimmingly for stock investors.

However, I think it is vital to understand that those living in a capitalist society already have an implicit tilt towards prosperity. To view your investment portfolio in isolation is to ignore one of your most valuable assets, your human capital. For most people, human capital is the prime wealth generating asset they own. Most of us generate income from this asset by renting it out to corporations in the form of wage labor. We cannot see the value of our human capital fluctuate tick by tick like we can with the stock market, but both are strongly correlated with economic prosperity. We are likely to get paid more in boom times (especially with commission driven compensation), and we are subjected to the risk of unemployment in the subsequent crashes.

Because citizens operating in a capitalist society already have this implicit tilt towards prosperity, I think an economically agnostic investment portfolio operating in the background is extremely rational. Life as a wage laborer or entrepreneur is fraught with risks relating to economic prosperity and to have an economically agnostic portfolio gives greater flexibility when recession strikes. One hates to draw-down on their investment portfolio to pay for expenses, but at least with the PP the flexibility is there if you need it.

1 comment:

  1. I think what you are saying kind of backs into Harry Browne's recommendation to simply save more money rather than take more risk if you want a larger nest egg.

    One of the things I like about the PP is that it provides favorable risk balancing when compared to your job, since the conditions under which you might lose you job are the worst time for your investments to also be doing poorly.