When it comes to investing, diversification is often described as the only free lunch available. For those who want to grow their wealth while also minimizing the chances of large drawdowns, diversification is key. This is especially true if you need to make regular withdrawals—perhaps during retirement. The last thing you want is to be forced into selling assets during a market downturn, locking in losses that could have otherwise recovered. Diversification helps spread risk across different types of assets, aiming for smoother returns, even in challenging market conditions.

Ray Dalio, one of the most respected names in the world of finance, popularized a strategy called the "All Weather Portfolio," designed to be resilient in all market environments.

Who Is Ray Dalio?

Ray Dalio is an American billionaire investor, author, and philanthropist. He is the founder of Bridgewater Associates, one of the largest and most successful hedge funds in the world. Dalio's professional life has been defined by his unique approach to investing, focusing on deep economic analysis and risk management. He's widely known for his principles-based approach to business, which he shared in his bestselling book, Principles: Life & Work.

Dalio started Bridgewater Associates in 1975 from his apartment, and over the decades, he turned it into a financial powerhouse by employing a systematic and disciplined approach to investing. His innovative strategies have earned him recognition as one of the most influential thinkers in the finance world. An interesting anecdote that often comes up about Dalio is how Bridgewater predicted the 2008 financial crisis well ahead of time, which allowed the fund to navigate the chaos far better than most.

Ray Dalio invented the All Weather Portfolio as part of his goal to create a balanced investment approach that could withstand all types of economic conditions. His philosophy revolves around the idea that the future is inherently uncertain, and the best way to prepare for it is to build a portfolio that is well-diversified and adaptable.

What Is the All Weather Portfolio?

The All Weather Portfolio is an investment strategy designed to perform well under a variety of market conditions. The idea behind it is simple: economic cycles are unpredictable, and the best way to protect yourself as an investor is to have a balanced mix of assets that thrive in different environments. This portfolio seeks to mitigate risk and deliver more stable returns, making it an attractive option for investors who value consistency and long-term growth.

The All Weather Portfolio consists of five major asset classes: stocks, long-term bonds, intermediate-term bonds, commodities, and gold. Each asset class is intended to respond differently to changing economic conditions—whether that means growth, recession, inflation, or deflation. By having exposure to these different types of assets, investors reduce the overall risk of their portfolio, as losses in one area may be offset by gains in another.

Here's a simplified breakdown of the All Weather Portfolio allocation:

• 30% Stocks: Probably the most well-known investment vehicle. Stocks represent ownership in companies, and their value tends to increase as companies grow and the economy does well. We will use the exchange-traded fund (ETF) SPY in this blog post, which invests in the S&P 500 large cap stock index.
• 40% Long-Term Bonds: Bonds are essentially loans that you give to governments or companies, and long-term bonds have maturities of over 10 years. They provide fixed interest payments over time, and their value often goes up when interest rates fall. We will use the ETF TLT here, which invests in US Treasury Bonds with a 20+ year maturity.
• 15% Intermediate-Term Bonds: Intermediate-term bonds have maturities of around 5-10 years. They offer a balance between the stability of shorter-term bonds and the higher returns of long-term bonds. We will use the ETF IEI here, which invests in US Treasury Bonds with a 3-7 year maturity.
• 7.5% Gold: Gold is a precious metal that has been used as a store of value for centuries. It is often bought by investors to protect against economic uncertainty and inflation. We will use the ETF GLD in our example.
• 7.5% Commodities: Commodities are raw materials like oil, wheat, and metals. Their value tends to rise with inflation, making them a useful hedge against the rising cost of goods and services. We will use the ETF GSG in our example, which invests in a braod spectrum of commodities.

How the All Weather Portfolio Adds Resilience

The All Weather Portfolio is designed to handle various economic scenarios by allocating assets in a way that ensures there is always some part of the portfolio performing well, no matter the economic climate. Here are some specific scenarios in which the All Weather Portfolio adds resilience:

• Economic Growth: During periods of economic growth, stocks tend to perform well, driving portfolio gains. The 30% allocation to stocks captures the upside of economic expansion.
• Recession: In times of recession or economic contraction, bonds—particularly long-term bonds—tend to perform well as interest rates are often lowered to stimulate the economy. The 40% allocation to long-term bonds helps cushion the blow during these periods.
• Inflation: During inflationary periods, commodities and gold generally perform well, as they are seen as stores of value. The 7.5% allocation to each of these asset classes helps protect against the eroding value of money.
• Deflation: During deflationary periods, long-term bonds become more valuable as interest rates fall, and their fixed interest payments become more attractive. The significant allocation to bonds helps provide stability in such scenarios.
• Economic Uncertainty: Gold is often seen as a safe haven during periods of economic uncertainty or geopolitical risk. The allocation to gold helps protect against sharp declines in other asset classes.

Comparing the All Weather Portfolio to the S&P 500

The All Weather Portfolio's primary goal is to provide stability and reduce risk, whereas the S&P 500 is a stock market index that tracks the performance of 500 of the largest publicly traded companies in the United States. The S&P 500 is heavily concentrated in equities, which means it is more volatile and subject to larger drawdowns during market downturns. The plot below shows the historical performance of both investements, strating in 1993 (we used proxy data for time periods when ETFs were not available):

Historically, the All Weather Portfolio has provided lower but more consistent returns compared to the S&P 500. For example, during the 2008 financial crisis, the S&P 500 experienced a drawdown of over 50%, whereas the All Weather Portfolio saw a much smaller decline due to its diversified nature. While the S&P 500 tends to outperform during bull markets, the All Weather Portfolio is better suited for investors who want to avoid large losses and prefer a smoother ride.

Over the long term, the All Weather Portfolio may underperform the S&P 500 in terms of total returns, especially during strong bull markets. However, it offers a more balanced risk-reward profile, making it ideal for investors who prioritize capital preservation and lower volatility. The key benefit of the All Weather Portfolio is that it allows investors to stay invested through different economic conditions without the need to make drastic changes, providing peace of mind and financial resilience.

The best of both worlds

At Invest-with-code.com, we seek to provide both, the outperformance of the S&P500 index, but also the consistent returns of the All Weather Portfolio. We accomplish this by softening the strict static portfolio allocation weights of the classic All Weather Portfolio. We do not always invest 7.5% in Gold. Instead, we use Bayesian statistics to quantify the probability that Gold currently outperforms other markets, and increase the its allocation weight if this probability is high. How this method works in detail, we will discuss in the next blog posts. Stay tuned!