Timing And Dollar Cost Averaging

The Permanent Portfolio Fund (PRPFX) is a no-load mutual fund offered by the Permanent Portfolio Family of Funds that relies on a unique asset-class diversification theory similar to a strategy developed in the early 1970s by famed investment newsletter writer and best-selling financial-markets author Harry S. Browne (1933-2006). After extensive testing, Browne found that a permanent investment portfolio made up of equal allocations from the following four classes of financial instruments was likely to provide long-term protection from the ravages of inflation, while also allowing an investor the ability to capitalize on whichever of the four asset classes were outperforming at any given time:

1. Physical gold and silver (bars, coins, or bullion)
2. US Treasury bonds and/or notes
3. Leveraged stocks -- that is, stocks with a higher beta (measure of statistical volatility) than the broad market indexes
4. Cash deposits (insured certificates of deposit, money market funds, and so forth)

According to Browne's original concept, this portfolio would initially be funded with 25% of an investor's available capital into each of the four asset classes. Over time, one or more of the classes would begin to out- or underperform the others, necessitating restructuring work. Rebalancing the portfolio back to the initial 25% allocation per asset class was to be performed anytime that one of the asset classes dropped to 15% or climbed above 35% of the portfolio value. This ensured that all asset classes had an equal shot at pulling the overall weight of the entire portfolio, since it was presumed that no one can consistently time the market and/or determine which of the four asset types would be the next big winners (or losers).

ENTER PRPFX
In late 1982, the Permanent Portfolio mutual fund (PRPFX) was launched to help make it easier for investors to take advantage of Browne's asset allocation/rebalancing concept; no longer did an investor need to go through the hassle of buying/selling gold bullion, stocks, CDs/money markets accounts and Treasury bond/T-bills at rebalancing time. With PRPFX, they could make an initial investment in the fund (and add to it periodically if desired), knowing that the fund's manager was going to handle all of the specific asset class allocations and rebalancing tasks on an ongoing basis.

Incredibly, since the fund's launch on December 1, 1982, it has experienced only four losing years -- in 1984, 1990, 1994, and 2008. While it's too early to discern if 2012 will be another winning year for the fund, as of November 16, PRPFX closed at 48.40, up more than 5% from 2011's year-end close of 46.09.

With that brief primer on the principles surrounding the philosophy and operation of the fund out of the way, let's see if there might have been a significant advantage in one style of dollar cost averaging over another during the past 16-plus years, beginning on July 1, 1996.

TWO PATHS, SAME CAPITAL, DIFFERENT OUTCOME
Method 1 specifics:

1. Initial purchase amount $600 on July 1, 1996
2. Subsequent purchases were made on the first trading day of each month thereafter, starting with $100 a month
3. On the first trading day of each year, the contribution amount was increased by 5% to help offset the effects of inflation ($100, $105, $110.25, $115.76, and so on)
4. As of November 1, 2012, the total purchase amount was $30, 585.

Additional details:

5. Adjusted share prices were used for all calculations to account for the effect of dividends and splits
6. Taxes on dividends and capital gains distributions were not taken into account; long-term investors might be better served to use this style of investing in tax-deferred accounts instead of those that are taxable
7. Yahoo Finance historical data was used for all testing.

Method 2 specifics:

1. Initial purchase amount $1,800 on July 1, 1996
2. Subsequent purchases were made on the first trading day of every July thereafter, remaining static at $1,800
3. As of November 1, 2012, the total purchase amount was $30, 600.

Additional details:

4. Adjusted share prices were used for all calculations to account for the effect of dividends and splits.
5. Taxes on dividends and capital gains distributions were not taken into account; long-term investors might be better served to use this style of investing in tax-deferred accounts instead of those that are taxable.
6. Yahoo Finance historical data was used for all testing.

LOGICAL ASSUMPTIONS?
From the information given, you have probably already noticed that the two methods of dollar cost averaging (DCA) are based on a completely different worldview: the first one is to simply purchase shares on the first of every month, increasing the allocation by 5% on the first day of every subsequent trading year. The latter method simply makes one large annual contribution on the first trading day of July, never increasing the allocation for inflation for subsequent annual contributions.

THE BATTLE BEGINS
Since the only thing that matters in successful investing is the real-life returns obtained from the endeavor, here are the final statistics from this 16-plus year backtest:

Method 1 (Figure 1):
Net purchases: $30,585
Number of shares: 1300.94
Number of purchases: 196
Current value: $64,019
Percentage gain: 109.32%
Maximum drawdown: (20.90%)
Length of maximum drawdown: Five months (July 1 to December 1, 2008)

FIGURE 1: DOLLAR COST AVERAGING IN PRPFX USING METHOD 1 (JULY 1, 1996 TO NOVEMBER 1, 2012). Method 1 required 196 monthly purchases with a percentage gain of 109.32 and maximum drawdown of 20.90%.

Method 2 (Figure 2):
Net purchases: $30,600
Number of shares: 1440.32
Number of purchases: 17
Current value: $70,878
Percentage gain: 131.63%
Maximum drawdown: (22.96%)
Length of maximum drawdown: Five months (July 1 to December 1, 2008)

FIGURE 2: DOLLAR COST AVERAGING IN PRPFX USING METHOD 2 (JULY 1, 1996 TO NOVEMBER 1, 2012). Method 2 require 17 purchases with a percentage gain of 131.63 and maximum drawdown of 22.96%.

OBSERVATIONS

1. Method 2 only required 17 purchases (one per year), whereas method 1 required 196 monthly purchases.
2. Method 2's current open profit is more than $6,800 higher than method 1's profit.
3. The maximum drawdowns for both methods are similar in both percentage terms and in duration.
4. Method 2 required less effort and provided substantially higher returns.

Part of the difference between the returns in both percentage and dollar gains terms appears to be due to the difference in the initial funding amounts: $600 for method 1 and $1,800 for method 2. By establishing a larger initial position in method 2 when PRPFX was at 13.03, you could say that method 2 gained a significant head start over method 1, which took a much smaller initial stake. Another reason for the outperformance of method 2 is likely due to PRPFX trading in a generally sideways range between 1996 and 2001 and instead of progressively increasing the purchase amounts during that period like method 1 did, method 2 simply played it safe, putting in the exact same amount of cash every July.

During the powerful rally in the fund between 2002 and mid-2008, method 1 kept its progressively larger purchases even as the fund hit new highs; this also increased the amount of pain during the 27.16% drawdown that PRPFX endured between July 2008 and February 2009 (Figure 3). Finally, for the past 18 months, PRPFX has traded in a fairly wide range. Method 2 always keeps an even keel, simply buying $1,800 every July 1, while method 1 has slowly been increasing its purchase allocation since the consolidation started.

FIGURE 3: PRPFX, MONTHLY. Note the 27.16% drawdown the fund endured between July 2008 and February 2009.

Regardless of the underlying reasons for the noticeable outperformance of method 2 versus method 1, it seems clear that making one large purchase per year in PRPFX offers several potential advantages when compared to the results produced by the steady, small purchases made on a monthly basis, as mentioned previously.

This backtest also raises new questions. For example, should the purchase allocation of method 2 be periodically increased to help protect against inflation? And if yes, then by how much? Perhaps one simple solution would be to increase the $1,800 allocation by a certain percentage (at its next scheduled annual purchase date) whenever PRPFX experiences a monthly drawdown of 5% or more. Another possible solution could be to increase the initial $1,800 allocation every third year by 5%; this arrangement (method 3) produced slightly less profit than method 2, but still managed to greatly outdistance method 1:

I'LL TAKE DOOR 3, MONTY
Of the three methods for dollar cost averaging into PRPFX, the last is likely the best choice, and for these reasons:

1. Only one annual contribution is required, instead of 12 per year
2. A gradual increase in the amount of cash allocated for purchases, ensuring that the effects of inflation are minimized to some extent.

While no one knows if any of these DCA methods into PRPFX will continue to provide similar (if any) profits in the months and years to come, that all three methods did acceptably over the past 16 and a half years should provide some degree of confidence for those who may be inclined to build a long-term position into this uniquely diversified mutual fund.

IS PEACE OF MIND POSSIBLE?
Dollar cost averaging aside, PRPFX appears to offer risk-averse, long-term investors an interesting and convenient way to retain continuous exposure to four specific investment asset classes, relieving them of the hassle of rebalancing (not to mention the buying and selling) of the physical assets. With PRPFX, the fund manager does all of the hard work of rebalancing the four asset classes, leaving the investor with the task of carrying out a consistent plan of dollar cost averaging that makes sense in the real world.

For long-term investors who can stay the course with one of the dollar cost averaging plans discussed here, the peace of mind obtained by owning a fund that has historically modest drawdowns might be the ticket that gets them started on the road to low-risk, long-term investing success. A spreadsheet to test and find optimum allocations is available for download here.