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  • Nicholas Pihl

Dalio's All Weather Portfolio

Updated: 5 hours ago

Ray Dalio popularized the concept of the "All Weather Portfolio," an asset allocation strategy that is diversified enough to perform decently across a broad range of economic conditions. He suggests that macroeconomic environments are defined according to two main variables: economic growth, and inflation The performance of different asset classes, he expects, should correspond to the direction of these two variables.


For instance, in a disinflationary, rising growth environment, he expects equity investments to perform well. And indeed, that's exactly what we've seen over the last 10 years. Conversely, in the 1970s, you saw the unusual combination of declining growth and rising inflation. This was a great performance period for gold and hard assets, but a poor one for stocks. And finally, in periods of both declining prices and declining growth, high quality bonds have performed very well.


Accordingly, he advocates for a broadly diversified portfolio composed of 30% equities, 40% long-term US bonds, 15% intermediate term bonds, 7.5% gold, and 7.5% commodities. The point of most of these holdings is not to pick the asset class that will perform best over the long haul, but to select a blend that minimizes drawdowns and allows you to rely on your portfolio through thick and thin.


It's an attractive concept in its simplicity, as well as its branding. The name "All Weather" connotes ruggedness, and stability. And in fact, backtests going back to 2002 look pretty good when it comes to managing risk. Its largest drawdown was less than 15%, compared with a little over 50% for the S&P 500. The returns it delivered were good too, at least on a risk-adjusted basis, at 7.71% annualized. The S&P 500 though, despite its higher volatility, offered 10.49% returns over the same period. Over longer periods, too, the All Weather Portfolio underperformed both the S&P 500, and a simple 60/40 portfolio of stocks and bonds, as Nick Maggiulli points out here.


So what does this mean for you? Well, it really depends on your appetite for risk, your need for growth, and your timeframe for when you'll need the money. The greatest feature of the All Weather Portfolio is its stability. For someone nearing retirement who intends to draw on their portfolio within the next 5 years, there are worse ways to invest your money. But for someone who is primarily concerned with growing their assets, it may not be a good fit. (As always, don't just base your decisions off this one article. I really encourage you to engage a knowledgeable professional who knows your situation.)


Look again at what this portfolio is invested in. Roughly 55% bonds, 15% gold and commodities, and only 30% stocks. Over the last century, bonds have kept pace with inflation (at least on a pre-tax basis), as has gold. The other commodities, though, despite brief periods of huge gains, have actually gotten cheaper in real, inflation-adjusted terms due to what happens when human ingenuity interacts with competitive markets.

Still, inflation shocks and equity bear markets are serious concerns over the short term, and these are the wealth-management problems that the All Weather Portfolio is designed to solve. This really illustrates the intent of the portfolio. It isn't primarily intended to produce wealth for the long term, so much as preserve wealth for the short term.


This is really my main issue with Dalio's strategy. It suggests putting 70% of your money in asset classes that don't actually produce anything. Sure, this is a fair choice for storing money that already exists, but these investments don't actually increase the pool of resources available to you or your fellow humans. And when it comes to preparing for hard times, tying up 70% of your wealth in nonproductive assets just seems excessive to me. 20-30%, depending on your situation, seems like a more appropriate buffer.


Returning to the concept of different economic environments, I did the same exercise a couple years ago, but with the types of businesses I'd want to own. Sure, commodity producers of oil, steel, and soybeans have their day in the sun when inflation heats up. Value stocks tend to be less adversely affected by rising interest rates than growthier names. Growthy businesses, meanwhile, do well when the economy as a whole is relatively stagnant. But whether rates are rising or falling, growth is high or low, and inflation is hot or cold, I think the class I most want to own through thick and thin consists of quality businesses with pricing power. In environments of rising costs, they have the ability to keep supply costs down, or pass on price hikes to consumers to preserve their margins. In slow environments, they can continue to allocate capital efficiently and achieve good earnings growth. And in recessions, they have the balance sheet that allows them to make investments for the next phase of growth, but at bargain basement prices. These are the companies that both create wealth, and can weather a wide variety of economic environments. They may lag at times when any of the other categories really shine (and for this reason, I still embrace diversification), but overall I want that core portfolio to have high quality.


To wrap up this discussion on portfolio construction, my bias is to own great businesses for the long run. I believe fundamentally in that process of value creation. The reasons to deviate from that are usually to manage an upcoming cash need, whether retirement living expenses, purchasing a home, or starting a new business. After all, while stocks are the long-term winners, they've had some pretty bumpy years along the way. You want to make sure those bumps don't throw you off your goals, which is what Dalio's portfolio does (arguably too much so). My own solution to this problem, rather than a one-size-fits-all approach, is to make sure the portfolio and financial plan are designed uniquely for each individual client to promote progress towards their long term goals, while preparing for the risks and opportunities of their unique situation. They hold cash for specific needs, not just for the sake of maintaining arbitrary allocations.





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