The profitable ETF portfolio built to survive a market crash (2024)

It’s tough to forget the stock market crash of 2008. Portfolios tumbled. Investors felt like they had eaten plates of rotten fish. Unfortunately, another crash is coming. We don’t know when, but the sun always sets on every bright bull market.

Some people like market crashes. If they’re investing every month, they celebrate like it’s a Boxing Day sale. But most investors hate to see their hard-earned money plummet. Unfortunately, if we want to make profits, we have to accept the short-term risks. At least, conventional wisdom says we do.

But at least one portfolio idea turns such wisdom inside out. The late American writer, politician and investment adviser Harry Browne created the Permanent Portfolio in 1981, which includes an equal mix of stocks, long-term bonds, cash (or short-term bonds) and gold. Mr. Browne said it would deliver smooth investment returns. He also said it wouldn’t crash when stocks fell off a cliff. Thirty-eight years later, we know that he was right. Today, you can also build this portfolio with specific exchange-traded funds (ETFs).

Consider the market free-fall from January, 2000, to January, 2003: Measured in U.S. dollars, U.S. stocks plunged 10.57 per cent in 2000. In 2001, they fell another 10.97 per cent. If that wasn’t bad enough, they dropped a further 20.96 per cent in 2002. But instead of riding the downward slope, Mr. Browne’s portfolio actually made money. It gained 2.97 per cent, 0.56 per cent and 6.63 per cent, respectively.

In 2008, Canadian, U.S. and international stocks fell even harder (see charts), but the Permanent Portfolio dropped less than 4 per cent. Skeptics might wonder if it has earned decent profits. Over the 20 years ending Oct. 31, 2019, the portfolio averaged a compound annual return of 6.91 per cent. That compares with 6.8 per cent for U.S. stocks and 5.96 per cent for a portfolio allocated 60 per cent U.S. stocks and 40 per cent U.S. bonds.

Over longer periods of time, the Permanent Portfolio doesn’t beat the market. Over the 36 years between 1983 and 2019, it averaged a compound annual return of 7.79 per cent. That compares with 10.92 per cent for U.S. stocks. But the Permanent Portfolio was easier on the nerves. Its worst year was 2008, when it dipped a paltry 3.59 per cent.

The Permanent Portfolio needs to be rebalanced once a year to maintain its four-way split between stocks, long-term bonds, cash (or short-term bonds) and gold. These assets often move in opposite directions. That’s what keeps the portfolio stable. When stocks drop, for example, long-term bonds, gold or short-term bonds often rise.

Mr. Browne’s original portfolio included just U.S. stocks, U.S. bonds, cash and gold. But Canadians can reduce currency risk by replacing U.S. bonds with Canadian bond ETFs. And they can diversify the portfolio further by including a Canadian and a global stock market ETF, instead of just using a U.S. stock index.

Here’s how you could allocate 25 per cent in stocks: Investors could put about 12.5 per cent of their portfolio in a broad Canadian stock ETF, such as Vanguard’s FTSE Canada All Cap Index ETF (VCE). It includes about 200 Canadian stocks: large-cap, mid-cap and small-cap companies. Its management expense ratio (MER) is a paltry 0.06 per cent a year.

Investors could then put an equal amount into Vanguard’s FTSE Global All Cap ex Canada Index ETF (VXC). It includes about 10,700 stocks. About 57 per cent of the holdings are U.S., with the remainder allocated to developed international and emerging markets shares. The MER is 0.2 per cent.

For the 25-per-cent long-term bond allocation, investors could select iShares Core Canadian Long Term Bond Index ETF (XLB). It includes about 200 Canadian government and corporate bonds with maturities longer than 10 years. The MER is 0.20 per cent.

When Mr. Browne devised the Permanent Portfolio nearly four decades ago, he recommended investors keep 25 per cent in cash. But savings accounts pay far lower interest today, compared with the early 1980s. That’s why Craig Rowland and J.M. Lawson, authors of The Permanent Portfolio: Harry Browne’s Long-Term Investment Strategy, suggested investors could replace cash for a short-term bond market index. That makes sense, considering that short-term and long-term bonds don’t always rise and fall together.

As such, investors could allocate 25 per cent of their holdings to iShares Core Canadian Short Term Bond Index ETF (XSB). It includes about 487 short-term government and corporate bonds, maturing before a five-year period. The fund’s MER is just 0.1 per cent.

Here’s the important part about this investment strategy: Don’t embrace the Permanent Portfolio if you think stocks will fall and then abandon the approach after stocks have recovered. And don’t try to speculate with these asset allocations. By doing so, most investors will end up buying high, selling low and earning poor returns. If the Permanent Portfolio sounds good to you, stick to the method and be sure not to waver.