Given that most portfolios fail to match the performance of the S&P 500 over the long-haul, you might be wondering why anyone would invest in anything other than a standard SPY fund at all.
But there might just be a better alternative to the evergreen index tracker, and it goes by the name of the All Weather Portfolio.
What Is Ray Dalio’s All Weather Portfolio?
The All Weather Portfolio is modeled off of the famous All Weather Fund first conceived by legendary hedge fund manager Ray Dalio. The concept was initially developed at Bridgewater Associates – the investment management firm co-founded by Dalio in 1975 – and has gone on to be imitated many times over ever since.
At its heart, the All Weather Portfolio is designed to survive and thrive in any kind of economic environment. The idea of a fund that can weather potentially any unforeseen market conditions is especially attractive to investors who want to be insured against so-called Black Swan events. It is also beneficial to investors with a low tolerance for risk, and those who place capital preservation as their primary concern.
The underlying principle behind Ray Dalio’s All Weather Portfolio is diversification – a strategy that reduces risk and mitigates volatility. The portfolio attempts to maximize diversification by including a wide variety of asset classes – such as stocks, bonds, gold and commodities. Because these different asset classes are all uncorrelated – i.e. stocks go down when bond rates tend to trend upwards – the portfolio should, in theory, deliver some level of positive performance, regardless of the actual returns of the individual assets themselves.
Unlike many other portfolios, the All Weather Portfolio is not strictly calculated on the basis of true risk parity. This means that the assets featured in the portfolio are not optimally weighted so as to match the overall level of risk tolerance that any investor would desire. That said, Bridgewater’s All Weather Fund appears to be consistent with the risk parity approach, and there are ways to modify the portfolio if you wish to correct this.
Ray Dalio derived the notion of an “all weather” portfolio based on his interpretation of the economic “seasons.“ Dalio believes that asset value is affected by four things:
- inflation,
- deflation,
- economic growth and
- economic recession.
Because of this, he describes the ”seasons“ of the economy as follows:
- Inflation growth higher than expected
- Inflation growth lower than expected
- Economic growth higher than expected
- Economic growth lower than expected
By choosing a mix of asset classes that perform well overall regardless of which “season” we’re in, Dalio created a portfolio that successfully minimizes volatility through diversification.
Ray Dalio All Weather Portfolio Holdings
The typical basis for an classic Ray Dalio All Weather Portfolio would break down something like this:
- 30% US-based stocks
- 40% long-term treasury bonds
- 15% intermediate-term treasury bonds
- 7.5% broad, diversified commodities
- 7.5% gold
As you can see, 55% of the portfolio is made up of fixed income securities, with only 30% being allocated to stocks and shares.
Gold is included to provide protection should there be a general devaluation in paper money, and commodities are a further hedge against the performance of stock market assets.
How Do I Make An All Weather Portfolio?
Now that you know the composition of the All Weather Portfolio, it’s time to start building one for yourself.
There are two basic approaches to this: You can either choose an off-the-shelf option which has been put together by a traditional brokerage or investment firm, or you can personalize your own All Weather Portfolio by picking your own exchange-traded funds (ETFs) – such as those commonly offered by Vanguard, VanEck, iShares and Invesco. Either way, you should be able to arrange your portfolio with minimal costs and fees.
Given the fractions indicated in the last section, a model portfolio might look something like this:
- 30% iShares Trust – iShares Core S&P Total U.S. Stock Market ETF (ITOT)
- 40% Schwab Strategic Trust – Schwab Long-Term U.S. Treasury ETF (SCHQ)
- 15% SPDR Series Trust – SPDR Portfolio Intermediate Term Treasury ETF (SPTI)
- 8% VanEck Merk Gold Trust (OUNZ)
- 7% First Trust Exchange-Traded Fund VII (FTGC)
All Weather Portfolio Vs S&P 500: Track Record
Before we dive into the performance metrics of the All Weather Portfolio, it’s first worthwhile just reminding ourselves of what it is we want out of our fund. Certainly, we want to make a profit – if the portfolio doesn’t return positive growth of some kind, it’s not worth considering at all. But as we said in the introduction, if so many funds under-perform the S&P 500 so badly over the long-term, we’d be better off just sticking to the SPY unless there’s a compelling reason not to.
However, there’s a little more to it than that. One of the major reasons the All Weather Portfolio exists is to reduce volatility, and, also, to reduce draw-downs in the event that the market performs spectacularly badly.
To be precise, a draw-down is the amount a fund or portfolio falls from its highest to lowest position in a given time-frame. Mitigating the impact, or magnitude, or these draw-downs is another important aspect of the All Weather Portfolio.
So, how do the S&P 500 vs All Weather Portfolio fare against one another?
OK, taking $10,000 as our initial investment, and measuring over the last 20 years of available data, it seems that the All Weather Portfolio ticks pretty much every box we want it to. The final balance for the All Weather Portfolio was $38,556 after two decades of trading, while the S&P 500 was $61,217, giving a CAGR of 7.71% and 10.49% respectively.
In its best performing year, the All Weather Portfolio grew 18.41%, while the S&P 500 grew 32.18%.
You might be thinking at this point: “But hold on, didn’t the S&P 500 easily return more capital than the All Weather Portfolio?” Yes, it did, but there are other metrics we need to be aware of too. Remember, we want our All Weather Portfolio to decrease draw-downs, as well as shield us from volatility.
Therefore, looking at the worst performing year for both funds, we see that the S&P 500 clocked a loss of 37.02%, while the All Weather Portfolio was down just 5.19%. The maximum draw-down for the All Weather Portfolio was also low at only 15.62%, whereas the S&P 500 lost 50.97%.
To get a better sense of how each fund fared, we can turn to the Sharpe Ratio. The Sharpe Ratio gives us a measure of the return on an investment in comparison to the risk associated with it. The higher the Sharpe Ratio number, the more upside there is for the investor. In our case, the All Weather Fund had a Sharpe Ratio of 0.96, and the S&P 500 a Sharpe Ratio of just 0.69 – suggesting that investors were more exposed to needless risk with the SPY index than they were eventually compensated for.
All Weather Portfolio + Bitcoin: A Better Choice?
Compared to most other securities on the market today, Bitcoin is definitely one of the newest kids on the block. But that doesn’t mean that the popular crypto-currency doesn’t have any utility for your All Weather Portfolio. In fact, BTC might be the missing element that takes your fund from just good, to great.
Indeed, the Ray Dalio All Weather Portfolio with Bitcoin seems to offer significantly increased profits with only a small fraction of the blockchain-based asset, as ring-fencing just 2% of your portfolio to include BTC reaps a 16.37% annualized return over 5 years.
Even Ray Dalio personally has his own stash of Bitcoin, describing the asset as being like “digital gold.”
Source: Unsplash
What Is The 2x Leveraged All Weather Portfolio?
It might seem counter intuitive to want to add leverage to a portfolio that is a low-risk, low-volatility play, anad that’s just what Ray Dalio and the fund managers at Bridgewater do with their own All Weather Fund.
Indeed, leverage in this scenario can have its benefits. While some people are put off the idea of holding leveraged positions for the long-term, it can actually work to your advantage. For instance, volatility decay has traditionally been seen as a wholly negative phenomenon when it comes to holding ETFs, since leveraged ETFs are rebalanced everyday. Over the course of time – so the theory goes – this rebalancing erodes the multiplied returns you would expect to receive with a leveraged fund.
However, volatility decay actually work to the investor’s advantage when there is strong upwards momentum in the market – and given that this occurs more often than it does when the market goes down, the perceived dangers of volatility decay are somewhat overblown.
If you’re happy with the risk profile of a leveraged portfolio, all you need to do is find a set of ETFs that fulfills the All Weather Portfolio asset mix, and which are also available with magnified exposure. An example of such a portfolio is given below:
- 30% ProShares Trust – ProShares Ultra S&P500 (SSO)
- 40% ProShares Trust – ProShares Ultra 20+ Year Treasury (UBT)
- 15% ProShares Trust – ProShares Ultra 7-10 Year Treasury (UST)
- 7.5% ProShares Trust – ProShares Ultra Oil & Gas (DIG)
- 7.5% ProShares Trust II – ProShares Ultra Gold (UGL)
The same principle also applies for a 3x leveraged All Weather Portfolio too.
The benefits of a leveraged portfolio aren’t just limited to higher absolute returns either. It turns out that the Sharpe Ratio can improve with leverage, and, perhaps surprisingly, the worst year and maximum draw-down numbers still remain better than the S&P 500 index too.
In addition to utilizing leverage to improve the performance of your All Weather Portfolio, you could also swap out the commodities in there and replace them with utilities instead. Commodities have historically been used as a hedge against inflation and uncertainty, but it’s not clear that this is such a robust belief: Commodities themselves are inherently unpredictable, with crops failing and the supply of raw materials at the mercy of innumerable deleterious factors.
A better option could be to rely on utility stocks as an alternative to regular commodities; utilities have had the lowest correlation to the wider stock market over the last twenty years, and the fundamentals of the industries to which they are tied make them reliable assets. Utilities are normally essential services that are non-cyclical, and which there is near constant demand.
So maybe switch-out that commodity fraction for an energy or water company instead.
Optimized Rebalance Interval
Leveraged portfolios will need to be rebalanced periodically, with the optimal rebalancing frequency dependent on many things. Some money managers will have a rebalancing trigger, such as a certain percentage drift on an asset within the portfolio, while others will just rebalance every quarter or once a year.
Rebalancing can involve transaction fees and incur possible tax charges too, so there is that to consider also.
How Does True Risk Parity Affect Your All Weather Portfolio?
While the All Weather Portfolio offers a well-diversified set of assets that helps limit volatility, it doesn’t conform to the notion of true risk parity. This concept attempts to weigh each asset within the portfolio based on an allocation of risk, in which all assets carry the same amount of volatility.
If you want to implement true risk parity within your own All Weather Portfolio, you can either do this through leverage, or by adjusting the fractions of the individual assets in your fund. For example, in the Ray Dalio All Weather Portfolio, the risk adjusted allocations would look like this:
- 20% US-based stocks
- 15% long-term treasury bonds
- 40% intermediate-term treasury bonds
- 13% broad, diversified commodities
- 12% gold
Are Bonds A Risky Part of The All Weather Portfolio As Interest Rates Rise?
As you can tell by now, treasury bonds of various kinds make up a big part of any type of All Weather Portfolio. Their inclusion is critical as a counterbalance for the performance of stocks, given that there is inherent uncorrelation between how shares behave and the action of bonds – which is vital to minimizing draw-downs and volatility.
The problem with bonds, however, is that among many investors they don’t have the reputation that they deserve. Common concerns regarding the inclusion of bonds in an All Weather Portfolio include:
- Bonds are only for retirees
- Interest rates always go up – therefore bonds are going to be worthless
- Bonds have no utility at low yields
- Long-term bonds are too vulnerable to interest rate risk
- Stocks always outperform bonds
- Corporate bonds are a better option
On the face of it, some of these objections appear valid. But let’s dig a little deeper and see if they really hold up.
Firstly, it’s a fundamentally erroneous assumption to think that bonds necessarily lose value in an environment of rising interest rates: Bonds only lose money when rates are rising faster than analysts’ predict.
Bonds perform fine when rates increase in line with expectations. In fact, when rates rise, bond-purchasing institutions are buying new bonds at the higher rate, while at the same time they’re selling the old, lower rate bonds back to the market. It doesn’t hold that investors are stuck with one yield rate for the entirety of the investing horizon.
Another thing to remember is that the duration of the bond you’re buying should pretty much match the length of your given investing horizon too, which, all other things being equal, should return the bond’s par value with added interest.
To assume that shorter-term bonds are “safer” is to make the mistake that you can time the market, which in itself is a fallacy for the majority of investors and will not deliver you the profits you want on a consistent, recurring basis.
It’s also a mistake simply because, as a bond’s duration lengthens, average yields are more likely to increase – not to mention that long bonds perform better when stock markets crash.
As to the question of whether treasury bonds are better than corporate bonds, you have to keep in mind what the function is of having bonds in your portfolio actually is. Bonds are a hedge to stocks and shares. However, it’s known that treasury bonds are more uncorrelated to the market than corporate bonds, especially in times of market upheaval. This makes treasury bonds a superior diversifier for our portfolios in the long run.
Perhaps the most important concept to be aware of when it comes to the role of bonds in your All Weather Portfolio is the fact that we’re not thinking about the bonds in isolation, but rather as a component of a wider set of mutually complementary assets. Bonds are our “flight-to-safety” option when there’s a downturn in the other markets. And even if bonds are not the best diversifier in every scenario, they are still the best diversifier when it comes to all-round utility.
In What Other Ways Can You Protect Your All Weather Portfolio From Inflation?
If you’re not entirely convinced that long-term bonds are the best bet for hedging against rising interest rates and inflation, then there are still plenty of alternative ways to diversify your portfolio to get added insurance against downturns and volatility.
Popular substitutions for your long- and intermediate-term treasury bonds could potentially include:
- Financial stocks – banks often fare well when interest rates rise due to the extra money they make on loans and other interest-bearing products
- Chinese companies – China and the Asian markets in general have a lower correlation to that of the US
- Real estate investment trusts – these “brick-and-mortar assets” could offer possible diversification from other kinds of stock
- Short-term Treasury Inflation-Protected Securities (TIPS) – as the name suggests, these assets don’t just protect you from inflation, they actually benefit from it too
Review: Is the Bridgewater All Weather Portfolio A Good Investment?
Depending on your investment needs and the acceptable level of risk exposure you’re willing to tolerate, the All Weather Portfolio can make for an excellent investment for all kinds of investors.
While the original Ray Dalio fund offers sound diversification with its cautious blend of stock and bond allocation, more adventurous investors might be tempted with the higher returns expected from a leveraged portfolio instead. Whatever you choose, the All Weather Portfolio promises solid risk-adjusted gains, as well as protection from the worst of market downturns.
#1 Stock For The Next 7 Days
When Financhill publishes its #1 stock, listen up. After all, the #1 stock is the cream of the crop, even when markets crash.
Financhill just revealed its top stock for investors right now... so there's no better time to claim your slice of the pie.
See The #1 Stock Now >>The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.