mikedamas's comments

Stocks are inherently riskier than bonds. Lower on the capital structure of companies (last to have a claim on company assets) and stock cash flows have much greater uncertainty than bonds. The statement that "stocks have higher returns than bonds" should NOT lead one to invest too much in stocks in pursuit of those returns (yes, it has -- the "dumb money" you describe), since there is greater volatility of returns around the average.

Portfolios should be built upon bonds, with stock market risk layered-in only to a degree.

A few comments on the Permanent Portfolio (25% Gold, 25% Stocks, 25% Bonds, 25% Cash):

1) Cash is simply a bond - very short-term, but a bond. So, since the 25% that is in bonds is, presumably, a fund, they usually have a duration (interest-rate sensitivity) of around 5.0-6.0 (roughly equivalent to years). Add-in the same 25% allocation to cash (duration around zero), and you have a 50% bond allocation that is of duration around 3.0 - that is reasonable and happens to be the duration I target. However, 1) since I use individual bonds, I do not have the problem of realizing losses during rising interest-rates (laddered maturities, held to maturity), and 2) I manage the bond portfolio to capitalize on changing yield compensation for risk along the three dimensions of bond risk: credit, interest-rate (duration), and timing-of-cash-flow (ex. mortgage-backed securities) to achieve better fixed-income portfolios.

2) Gold of 25% is quite risky. A brief look at the historical volatility of Gold returns will show you that having such a large allocation to an investment class with such a high standard deviation increases portfolio volatility too much. Secondly, it is very difficult to determine when Gold is relatively "rich" or "cheap", because, unlike all other non-commodity investments that we all invest in, we cannot apply simple discounting math to either a) measure the market’s yield compensation for the risk (as with bonds), or b) measure the price relative to expected earnings/cash-flow (as with stocks) - Commodities have NO cash flows.

Last thought: What has been a better risk-adjusted hedge against inflation, Gold or 3-Month US Treasury Bills? Check it out. When inflation actually happens (not just inflation expectations), interest-rates rise -- that is not spurious correlation, that is just rational market behavior.

Recommended reading: The Intelligent Asset Allocator (Bernstein). My implementation of an asset allocation strategy includes a well-constructed bond portfolio using primarily individual bonds. see www.marylandcapitaladvisors.com, for example.