Many investors have a constant question, “how to balance risk and profit?“. Now, at first glance, it seems like a vague question. It isn’t in our hands to balance risk and profit, right.
If you got a yes in your mind, I am afraid that you may be wrong here. You can control the risk profiles of your portfolio.
I accept that managing risk is not an easy thing to do. And most people will need a lot of research and practice to do so. Even many may fail in doing so. But it’s not about failing here. If you learn how to balance your portfolio that can weather the ups and downs of the market, then it will be a simple equation for you.
Moreover, one thing that can help you determine if you like a laid-back approach will be trying out the All Weather Portfolio. I’ll say it’s like The Collatz Conjecture, simple yet complex enough that it’s not everyone’s cup of tea.
But, once you know the basics of this portfolio strategy, no one can stop you. The investment portfolio is built to have a stable performance during all market seasons. It can be the best investment strategy for those who love the hands-off approach.
If you are one of them, give this article a read and find out if All Weather Portfolio suits you or not.
- Ray Dalio designed the All Weather Portfolio.
- It provides a passive investment approach to investors who don’t like buying or selling stocks at the wrong time.
- It invests in US stocks, long-term treasuries, intermediate-term Treasuries, diversified commodities, and gold.
- All weather exposes 30% of assets on the stock market and 15% to commodities.
- A compound annual return of All Weather Portfolio in the last 10 years is 6.41%.
- The 10-year standard deviation is 6.08%.
About the All Weather Portfolio
It’s an investment strategy designed by Ray Dalio. The All Weather Portfolio is also known as the ‘holy grail’ of investing because it aims to do well in all economic conditions.
The strategy was first introduced by Bridgewater Associates. This strategy was titled “The All-Weather Portfolio.”
In the method, Dalio suggested that investors could achieve consistent returns by investing in a mix of asset classes that had low correlations with each other. Dalio argued that this diversification would allow investors to weather any storm and still come out ahead in the end.
Diversification is also one of the principles of the All Weather portfolio. Dalio’s explanation on how a diversified portfolio can weather all storms was:
When the portfolio has diversified assets, it reduces the risk and reduces volatility. The All Weather Portfolio will do the exact thing. It will attempt to increase diversification with the inclusion of asset classes like bonds, stocks, commodities, and gold.Ray Dalio
By this strategy, he tried to explain the perfect balance as all asset classes aren’t correlated. According to the portfolio, when the stocks tend to go down with the increase in bond rates, it should still provide good results.
The All Weather Portfolio Strategy
The All Weather Portfolio invests in four asset classes- US stocks, long-term treasuries, intermediate-term treasuries, commodities, and gold.
He insisted on investing in these asset classes because he believed that the value of assets gets affected by:
- Economic Growth
Based on this, he formed the market seasons that will be considered before investing.
- Inflation lowers than anticipated
- When inflation rises more than anticipated
- Economic growth decreases than anticipated
- Economic growth increases more than anticipated
According to him, these seasons should be considered before choosing a portfolio asset mix. And based on this season’s study, he created the All Weather Portfolio. A portfolio that minimizes the volatility successfully during all seasons through asset diversification.
Can the All Weather Portfolio “Weather” the Stock Market? – A Review
The US stock market smashed an all-time high in 2017 when it closed above 21,000. This followed a 12-day run, the longest streak after a 13 days stretch of 1987. But it crashed in early 2020 due to the pandemic. This crash made many investors worried about their investment future as the stock market took a big hit.
But, the All Weather Portfolio still managed to give good results. The portfolio lost 3.74%, while the S&P 500 index plunged 34%. So, it is pretty evident that the portfolio can weather all storms and come out on top even during the most volatile market conditions.
Even though the portfolio did well in the past, there’s no guarantee that it will also perform well in the future. So, it’s always better to consult a financial advisor and keep the future conditions in mind before building a portfolio.
Moreover, there are some good things and some bad but not so bad things about this portfolio that I have listed below.
The All Weather portfolio has various advantages that make it a good choice. So let’s look at some of the positives of this portfolio.
1. Low-Cost Investment Approach
The All Weather portfolio is a low-cost investment approach. The reason is that building an ETF portfolio is inexpensive. The brokerage firms mostly sell them commission-free or at a very minimal expense ratio.
This helps reduce the total cost of the portfolio and increases the chances of positive returns. Moreover, only the GSG’s expense ratio is slightly high at 1.25%. Otherwise, ETFs like VTI have only a 0.3% expense ratio.
Diversification is the backbone of this portfolio. The portfolio consists of various asset classes like bonds, stocks, commodities, and gold, providing good diversification. This reduces the overall portfolio risk. It also provides stability during volatile market conditions.
The All Weather Portfolio is a very transparent investment approach. The reason is that all the investments are held in exchange-traded funds(ETFs). So, the investors can easily check what they are holding without going through complex reports. Also, as all the holdings are public information, it helps to keep track of things.
4. Simple Implementation
Why I say that it’s easy to implement is because of the ETFs. You just have to buy the ETFs and perform rebalancing in the All Weather Portfolio. You can rebalance ETFs yearly or quarterly based on your preference. And you can rebalance easily using your brokerage account.
5. Low-Risk Structure
The shallow risk of this portfolio is due to its large proportion of defensive assets that benefit when stock prices fall and non-correlated assets. There’s a good chance the All Weather Portfolio won’t lose all money. Treasury bonds, for example, typically rise when stock prices plummet, and gold and other commodities frequently do so as well.
If this portfolio forfeits the money by any chance, then it is a problem with our investment plan. Why is it so? Because the portfolio holds assets known as saviors during the worst time, i.e., bonds.
6. Tends to Hedge Against Inflation
The portfolio holds a large percentage of commodities. These commodities in the asset mix help build a barricade against increasing inflation. This happens because the price of a commodity usually rises with inflation.
The All Weather Portfolio has some disadvantages also. So let’s take a look at some of the negatives of this portfolio.
1. Performance in Certain Situations
As the portfolio is designed to do well in all market conditions, it will not be able to outperform in certain situations. For example, stocks usually do better than other asset classes during an economic boom. But as the All Weather Portfolio has a large percentage of bonds and other defensive assets, it will not be able to give good returns during such periods.
2. Interest Rate Decline
During declining interest rates, the value of bonds held in the portfolio declines. It’s the market rule that bonds always act opposite to the interest rates. And this becomes a problem in the case of All Weather Portfolio. It’s a problem because, in this portfolio, you will dedicate 55% of the assets to bonds.
So, the portfolio will expose you to higher interest rate risk than you can afford. Moreover, increased investment in bonds also increases the inflation risk. Rising inflation affects the purchasing power if the portfolio’s performance is below expectations.
Historical Performance of the All Weather Portfolio
The performance of the weather portfolio is quite good as it has been able to provide positive returns in most market conditions. However, there was a period when the portfolio didn’t do well, and that was during the interest rate decline. In this case, the value of bonds in the portfolio declined. Hence, the portfolio’s overall return was affected.
Further, its performance based on various factors is explained below:
|10Y Annualized Return||7.05%|
The returns of the portfolio aren’t its major strength over the years. But, they are enough when compared to how much risk a portfolio can balance. The compound annual return of the last 20 years is 6.41%. The standard deviation for the same is 6.08%.
If I talk about a 30 years compound annual return, it is 8.12%. The standard deviation for 30 years return is 6.67%.
When it comes to the yearly returns, All Weather provided 8.08% in 2021.
A portfolio’s volatility is also a key factor. The inflated the volatility, the more risky the portfolio is. The All Weather Portfolio falls in the category of the low-risk portfolio as it has a standard deviation of 21%. This means that the portfolio will not see much volatility and provide stability.
Inner Workings of the All Weather Portfolio
The all-weather portfolio works on the basis of assumptions made by Dalio and his team. They created a theory where the relationship between asset class performance and changing market situations was analyzed.
They investigated whether various asset classes grow or fall. This growth or fall was further dependent on whether the economy was expanding or contracting and inflation levels.
This theory of Dalio and the team helped design the All Weather Portfolio. A working asset allocation was prepared that allows better results in both ups and downs of the market.
The All Weather Portfolio Asset Allocation
The asset allocation proposed by Dalio and the team and the one still working now is:
- 40% in long-term treasury bonds
- 30% in US stocks
- 15% in intermediate-term treasury bonds
- 7.5% in diversified commodities
- 7.5% in gold
How Can You Build the All Weather Portfolio Using ETFs?
You can use various exchange-traded funds (ETFs) to construct an all weather portfolio. The asset allocation proposed by Dalio and his team can be done using the following ETFs:
- 40% in iShares 20+ Year Treasury Bond ETF (TLT)
- 30% in Vanguard Total Stock Market ETF (VTI)
- 15% in SPDR Portfolio Intermediate-Term Treasury ETF (SPTI)
- 7.5% in SPDR Gold Shares (GLD)
- 7.5% in iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD)
Can You Leverage the All Weather Portfolio?
You can leverage an all-weather portfolio by using margin. This will increase the exposure to the market as well as provide higher returns, but with increased portfolio risk.
For a 2x leveraged portfolio, you only need to choose the perfect mix of ETFs. I have tried to make a pie which you can use if you can bear the raised risk.
|40%||(UBT) ProShares Ultra 20+ Year Treasury||Leveraged Bonds|
|30%||(SSO) ProShares Ultra S&P 500||Leveraged Equities|
|15%||(UST) ProShares Ultra 7-10 Year Treasury||Leveraged Bonds|
|7.5%||(UGL) ProShares Ultra Gold||Leveraged Commodities|
|7.5%||(DIG) ProShares Ultra Oil & Gas||Leveraged Equities|
In the same way, use this pie to build a three-times leveraged portfolio.
|40%||ProShares UltraShort 20+ Year Treasury (TBT)||Leveraged Bonds|
|30%||ProShares UltraPro QQQ (TQQQ)||Leveraged Equities|
|15%||ProShares UltraShort 7-10 Year Treasury (PST)||Leveraged Bonds|
|7.5%||MicroSectors Oil & Gas Exp. & Prod. 3x Leveraged ETN (OILU)||Leveraged Commodities|
|7.5%||Direxion Daily S&P 500 Bull 3X Shares (SPXL)||Leveraged Equities|
Are Leveraged Portfolios Suitable for Long-Term Investing?
The answer can’t be a single yes or no here. It’s because the leveraged portfolio isn’t completely bad for long-term investment. A study has explained the phenomena in detail, and they found it to be beneficial as well.
Undoubtedly the common warning about using leveraged ETFs will remain constant. The risk and volatility of the portfolio will obviously rise with increased returns.
But this has nothing to do with “volatility drag“; it’s the expense ratio or fees. Most ETFs with greater than one leverage charge an annual fee. The fee is about one percent. This foists a “fee drag” on the leveraged ETF.
Another factor here is the tracking error. Leveraged ETFs don’t hit their target return daily. The tracking error adds extra uncertainty to the ETF, and a volatility drag is created as a result. However, owing to the serial correlation and the small magnitude of the drag, the impact on returns is minor compared to fees.
Periodical Optimized Rebalancing
A periodical optimized rebalancing can help minimize the volatility drag associated with leveraged ETFs. This periodic optimization helps in two ways:
- First, it allows you to sell the loser and hold the winner. This automatically sells high and buys low, which is what we want to do.
- Second, it triggers tax selling at opportune moments. This also helps us in selling high and buying low.
Moreover, the best interval to rebalance the portfolio is quarterly. Refer to the below-given table to see the difference between the various intervals and how they affect the returns.
|INTERVAL||CAGR||ST. DEV.||MAX DRAWDOWN||SHARPE|
Risk Parity and the All Weather Portfolio
This technique aims to evaluate each asset in the portfolio on the basis of risk allocation, with all assets having the same volatility percentage.
Moreover, if you wish to get truly risk-parity with your All Weather Portfolio, do it via leverage or altering the percentages of every asset in the fund. For instance, the All Weather Portfolio’s risk-adjusted distributions would appear as follows:
- 40% in intermediate-term treasury bonds
- 15% in long-term treasury bonds
- 20% in US-based stocks
- 12% in gold
- 13% in diversified and broad commodities
Is There Any Way to Minimize Inflation Effects?
There are alternatives that you can use to hedge against inflation. Most people look for these ways because they believe that long-term bonds won’t protect them. But, it’s not like that. Long-term treasuries are included just to balance out the rising inflation.
But, if you still wish to have some sort of shield, you can diversify your portfolio. The long-term and intermediate-term treasury bonds in the portfolio can be replaced with:
- REITs – The companies that manage and sometimes own the real estate companies are REITs. Usually, they mark upside growth when inflation rises. That means it can also provide you with good dividends and returns during inflation.
- Financial stocks – During inflation, banks often produce well enough interest rates. The rise results from the extra money they get from the interest of products they lend and the loans.
- TIPS – Short-term Treasury Inflation-Protected Securities. The name explains it all. The incorporation of TIPS gives protection and benefits during the inflation period.
- CLOs – Collateralized loan obligations are multiple loans pooled into one security. If investing, you’ll get a scheduled debt payment. This payment is received from the underlying loans. They have a floating yield which helps in hedging inflation.
The All Weather Portfolio vs. S&P 500 – Performance Track Record
Whenever there is a comparison with S&P 500 index, one thing that strikes everyone’s mind is – it’s better. Well, yes, in terms of returns, it is better than Ray Dalio’s All Weather Portfolio. But in managing risk, NO!
I want to remind you of one crucial point here. The purpose of building an All Weather Portfolio is to decrease volatility and drawdowns. Return is one topic that will always depend on the risk. But, if we are talking of All Weather, it’s more about risk adjustment and not returns.
So, working on these terms, All Weather has performed well. If we look at the worst drawdowns in the past 10 years:
- The worst drawdown was In March 2020. All weather was down by -13.99%, and S&P recorded a drawdown of -33.72%.
- During the worst performing year of S&P, the loss was 37.02%. What about the All Weather Portfolio? 5.19%.
I think it’s almost clear why I said above that S&P 500 lacks risk management.
Let’s now compare the Sharpe Ratios:
- The current Sharpe Ratio of All Weather Portfolio is 0.90, considered sub-optimal. Therefore, it has a risk-adjusted-performance.
- The current Sharpe Ratio of S&P 500 is 0.98. It’s better than All Weather, but the difference isn’t much.
Therefore, we can say that S&P 500 is a clear winner when it comes to returns. But, in risk management and downside protection, the All Weather Portfolio takes the lead.
The Inclusion of Bonds in the All Weather Portfolio
Another question that might bother you is the inclusion of bonds in the All Weather Portfolio. As you already know the portfolio is constructed to maintain the risk at all times. That’s why some investors don’t prefer it because they think it to be risky. But, you should be aware that:
- Including bonds doesn’t increase the risk. In fact, it does the opposite. It decreases the portfolio’s volatility and makes it more consistent.
- The drawdowns are decreased as well when you add bonds to the portfolio. That means in a bear market scenario, you’ll lose less money than other portfolios.
- Moreover, thinking that bonds will lose money during rising interest is erroneous. It happens only when the interest rates rise faster than predicted.
- Thinking that long-term bonds aren’t safe is also a false assumption. It’s wrong because the average yield increases as the duration of bonds extend. Even long bonds have always performed well during market crashes. So, it’s a win-win situation.
Therefore, I can say bonds may not be best diversified. But when it arrives at an all-around utility, they are the best. You can even call them the “safety tool” of the portfolio.
Useful Tips for Optimum Investment
If you are convinced that this portfolio is for you and want to invest, I have some tips. These tips are related to investment and not just this portfolio.
- Don’t put all your eggs in a single basket. That means don’t invest all your money at once. Go for dollar-cost averaging. It will reduce the effects of volatility and help you buy the assets at a lower price.
- Invest for the long term. This portfolio is not for short-term gains. It’s for those who want to grow their money steadily over time.
- Keep your emotions aside. This is one of the most important things when it comes to investing. Don’t let your feelings guide your investment decisions.
- Review your portfolio regularly. This will help you in knowing whether you are on track or not.
- Rebalance portfolio at regular intervals. This will help you in maintaining the desired asset allocation and risk level.
- Constantly assess your risk tolerance. This is a must because your risk tolerance changes over time.
- Lastly, take the advice of a financial advisor. If at any point in time you feel like you are not on the right track, seek advice. This will help you manage your portfolio in the best way. Plus, it will save you from any blunder due to your negligence.
Investing in an all-weather portfolio is a good idea. But, it’s not for everyone. It all depends on investment goals and risk tolerance.
If you are ready to take an acceptable risk level and if it fulfills your need, All Weather is a good option. The typical Ray Dalio fund provides excellent diversification with a cautious bonds and stocks exposure mix. But for more daring investors, higher returns projected by a leveraged All Weather Portfolio may sound more enticing.
Whatever your choice may be, the All Weather Portfolio vows consistent risk-adjusted profits. Also, it’ll protect from the bad market dropdowns.