A quick heads up before we come to today’s piece: I am taking my “lecture with funny bits” about gold to the West End for one night only. October 19th is the date. (That’s the show I did at the Edinburgh Fringe).
If you like gold, you will like this show. I promise. It’s super interesting. You can get tickets here. Hopefully, see you there.
So, continuing the recent theme of portfolio allocation, today we talk cockroaches …
I narrated a documentary once about cockroaches. Never mind the repulsion we may feel towards them, they really are the most amazing creatures. In fact, that repulsion may work in their favour because nobody wants anything to do with them, thereby bettering their chances of survival.
Cockroaches have been around since before the dinosaurs. According to Wikipedia, they are some 320 million years old, having originated during the Carboniferous period. They are hardy as hell. They can survive and thrive in tropical heat or in freezing, sub-Arctic temperatures below minus one hundred degrees (Fahrenheit or Celsius). They can survive the dryness of the desert where there is no access to water, but they can also survive in and under water. Many cockroaches even survived the nuclear bombs dropped on Hiroshima in 1945 - they are known to be resistant to radiation. You can even cut off a cockroach’s head and it will live on, at least for a bit.
How nice to have a portfolio that is as hardy. We should all have something of the cockroach to our portfolios.
In the wake of the Global Financial Crisis back in 2009 I remember seeing a presentation by Marc Faber in which he described a portfolio for all economic weathers. It broke down as follows:
Dylan Grice, who at the time was an analyst with SocGen, advocated something similar. He called it the Cockroach Portfolio, after that most hardy of creatures.
But the idea of a permanent, cockroach portfolio for all weathers was probably first popularised by an 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 2 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 personal finance book, Fail-Safe Investing: Lifelong Financial Security in 30 Minutes. This portfolio would assure "you are financially safe, no matter what the future brings."
Browne’s idea was that there are four macroeconomic environments - four seasons if you like: inflation, deflation, growth and recession. One of those macroeconomic environments would always apply.
So his portfolio was allocated in such a way that some of it would perform well in each of those seasons.
All in all, therefore, Browne’s portfolio for all economic seasons looked something like this. (You would re-balance once a year to maintain that allocation)
Browne’s differs 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 a financial nuclear financial fall-out like a cockroach.
I have two criticisms.
First, if you go back to 1982, when Browne first conceived this portfolio, the S&P500 has outperformed by some margin. Sure, the cockroach portfolio is much less volatile, but what’s the point of it, when 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
A word on 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. 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. Perhaps they are a celebrity or sports star. Whatever.
Most of the time they were anything but diversified. Rather 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 I know the other day. He made $40 million in 2005-2006. But he was moaning about the fact that he stayed concentrated and so handed a vast lump of it back. Had he instead diversified and then grew his wealth at say 5% a year, he would now be sitting on a pot more than double that size. At 10% a year, he would now be sitting on over $200m.
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 tech or whatever. You’d be minted. But if you went all in on mining in 2013. You’d be borassic. I think you get the point.
My do very-little-portfolio is coming soon. Keep your eyes peeled.
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