Born in 1949 in New York City, billionaire investor Ray Dalio is the founder and co-chair of Bridgewater Associates: looking after $160 billion worth of investments, both the world’s largest hedge fund and one of its most successful. The son of a jazz musician, Dalio early on exhibited greater monetary than musical chops. At the tender age of 12, he started working as a caddie on a golf course where a lot of the people often discussed stock trading. Inspired by this, he splashed his $300 savings on shares of Northeast Airlines, a now-defunct regional carrier. His investment eventually tripled when control of Northeast was acquired by legendary aviation mogul Howard Hughes. Dalio was clearly onto something...
After graduating from Harvard Business School, Dalio did stints at the New York Stock Exchange and several investment banks before founding Bridgewater in 1975 out of his Manhattan apartment. Dalio’s experience trading currencies and commodities led to him focusing Bridgewater on “global macro” investment: investing in a wide range of assets globally and trying to make money from broad macroeconomic and political trends.
In August 2007, Dalio made headlines with his predictions that the world was on the brink of financial crisis. He was soon proven right – and while most of his peers hemorrhaged money in the subsequent years, Bridgewater managed to turn a profit. In fact, Dalio’s money-making prowess is nothing short of phenomenal: since the firm’s inception, Bridgewater has made over $50 billion in net investment profits, more than any other hedge fund in the world.
So what’s behind this remarkable success? There are many reasons, but foremost among them is Dalio’s strict adherence to a set of principles he’s developed over the years. Fortunately for us, the billionaire investor has shared many of these through speeches, memos – and in 2017, a 600-page bestseller called (you guessed it) Principles.
Above all, Dalio believes that cause-and-effect relationships exist almost everywhere – and that if you can figure them out, there’s money to be made. When investing in commodities like soybeans and corn, for example, Dalio would forecast demand by looking at how many cattle, chicken, and hogs were being fed and how much grain they ate: one of the “causes” in the cause-effect dyad (big shout out to Star Wars IX). To estimate supply, he’d look at how much soybean and corn acreage was being planted and how rainfall affected their yields – another “cause”. Dalio would then reconcile these two causes to arrive at the “effect” – how grain prices were likely to move in the future – and use that to profitably trade soybeans and corn.
Another key principle is diversification, which Dalio views as the holy grail of investing. This is especially true when it comes to different asset classes – groups of similar assets such as stocks, bonds, real estate, and so on – that don’t move in the same way in a given economic environment. Specifically, Dalio believes 15 such “uncorrelated” investments can reduce a portfolio’s risk by 80% without sacrificing any significant return. Who said there’s no such thing as a free lunch?
Dalio’s investing is also guided by the principle that economies and financial markets experience long-term cycles – and that it pays to understand these. If this sounds rather daunting, then you’ll be pleased to hear that the man himself put together a short video explaining how these cycles work. For now, suffice to say that the economy undergoes protracted expansion (e.g. after the 2008 financial crisis), contraction (e.g. during the Great Depression), and long-term trends when it comes to inflation – the rate at which the prices of goods and services increase. These different environments have different impacts on different asset classes – and Dalio thinks riding those long-term waves beats constantly trying to time the market.
He’s also an advocate for being radically open-minded. That means trying to avoid having any biases – and to accept when you’re wrong. No one knows this better than Dalio: in the early 1980s, he lost almost everything betting that the economy was about to head south, even testifying in Congress and on TV to that effect. When meltdown failed to materialize, the resulting losses forced Dalio to dismiss all his employees as he could no longer afford to pay them…
While Ray Dalio has a whole host of other principles, the ones above are some of his most important ones when it comes to investing. In this Pack we’re going to show you how Dalio put these principles into practice, creating a portfolio meant to perform well in all economic environments – and walk through how you can construct something similar...
The takeaway: Ray Dalio is a successful investor who sticks to a series of investment principles, including cause and effect relationships, riding long-term trends, diversification, and being radically open-minded.
Before we dive into a discussion of Ray Dalio’s famous All-Weather Portfolio, even seasoned investors may benefit from a reminder about strategic asset allocation – and how risk parity, a technique pioneered by Bridgewater Associates, aims to improve upon traditional versions of this.
Strategic asset allocation involves building a portfolio based on target allocations for different asset classes, and then rebalancing that portfolio regularly to make sure it stays that way. One well-known allocation is the “60/40 portfolio” – where an investor places 60% of their portfolio in stocks and 40% in bonds. A year later, stocks may have performed well but bonds declined – causing the portfolio’s value to skew 65% stocks and 35% bonds. Since that’s a deviation from their initial targets, the investor will then sell stocks and buy bonds to bring the whole portfolio back to a 60/40 split. So far, so simple. But how – and why – is such a mix determined in the first place?
The general idea is to have an allocation that provides a certain balance between risk and return over a long time horizon, tailored to the investor’s goals and therefore their risk tolerance. For example, a young individual saving for long-off retirement can afford to take on more risk – allocating a higher proportion to stocks because, while volatile in the short run, they also offer the highest long-term expected return. An individual very close to retirement, on the other hand, can’t afford to take on loads of risk – and so might lean more towards safer government bonds.
Dalio is a big proponent of strategic asset allocation: it fits in nicely with many of his investment principles. As well as supporting diversification, especially across different asset classes, strategic asset allocation is an investing strategy that tries to capture long-term market cycles. It also shuns bias. For example, some investors might avoid shares after a big stock market crash but in retrospect, that would probably have been the most opportune time to buy stocks. Strategic asset allocation, with its constant weighting to different asset classes, is an inherently open-minded strategy that makes sure you’re invested during both good times and bad – and that tends to pay off in the long run 🎉
As Dalio himself puts it:
"The most important thing you can have is an excellent strategic asset allocation mix. In other words, you're not going to win by trying to get what the next tip is – what's going to be good and what's going to be bad. You're definitely going to lose. So what the investor needs to do is have a balanced, structured portfolio – a portfolio that does well in different environments."
– Ray Dalio
One of strategic asset allocation’s benefits, in other words, is that it’s diversified across different asset classes that tend not to move in lockstep – both reducing risk and allowing a portfolio to hold up well in different environments. Infrequent rebalancing, meanwhile, means less wasted money on trading fees and better tax treatment. Strategic asset allocation is designed as a hands-off approach that doesn’t require massive amounts of time and resources. As a buy-and-hold strategy, it reduces the human error of trying to time the market or letting emotions interfere with investment decisions. And best of all, the technique can be easily implemented using exchange-traded funds (ETFs) that track broad asset classes such as stocks, government bonds, corporate bonds, commodities, and so on.
One of the main criticisms of strategic asset allocation, however, is that it’s too focused on arbitrary capital allocation rather than risk allocation. A typical 60/40 portfolio, for example, splits money between two types of investment that don’t tend to move in the same direction. But the problem is that stocks are a lot more volatile than bonds, and a 60/40 mix means the bulk of a portfolio’s risk is coming from stocks’ piece of the pie – as illustrated below.
While you might think a 60/40 strategy delivers a well-diversified portfolio, in reality its performance will closely follow that of the stock market. That’s the problem risk parity – a technique pioneered by Dalio’s Bridgewater Associates – is trying to solve. The aim of a risk parity portfolio is to set the asset class weightings such that the contribution to overall portfolio risk from each asset class is the same – as illustrated below. In practice, this means lower exposure to stocks than traditional portfolios (due to their higher volatility) and more exposure to bonds.
Not only did Dalio pioneer the risk parity approach, but Bridgewater Associates also created the first risk parity fund: the All-Weather Portfolio. More on that next...
The takeaway: Strategic asset allocation is a sensible investment strategy, albeit one which aims to divide cash rather than risk – and that's the problem Dalio’s risk parity approach seeks to solve.
Ray Dalio created the All-Weather Portfolio in the mid-1990s. He wanted to invest his and his family’s accumulated wealth in a way that would prosper regardless of the economic environment; a portfolio that “will do reasonably well 20 years from now even if no one can predict what form of growth and inflation will prevail.” Today, virtually all of Dalio’s family wealth is invested in the All-Weather Portfolio – and Bridgewater Associates also has around $80 billion of client cash invested in the strategy.
So what’s in it? Dalio spilled the beans on a basic version of the All-Weather Portfolio during an interview, and it consisted of the following: 40% in long-term Treasuries (US government bonds with over 20 years left till maturity), 30% in US stocks, 15% in intermediate-term Treasuries (US government bonds with 7-10 years left till maturity), 7.5% in gold, and 7.5% in other commodities.
You can see risk parity at play here. Bonds, which tend to have the least volatility, have the highest weighting in the portfolio. Stocks come second; while commodities, typically the most volatile investments, have the smallest weighting. Based on the above, the contribution to overall portfolio risk from each asset class is roughly the same.️
That explains the weightings – but why did Dalio choose these investments in particular? It goes back to his principles of cause-effect relationships, diversification, and the market undergoing long-term cycles. Dalio purposely wanted a portfolio spread across asset classes whose characteristics are best suited to different parts of the cycle, which Dalio defines in two dimensions: rising/falling economic growth and rising/falling inflation. These are the “causes” which lead to the “effect” of diverging asset class performance.
To illustrate this, let’s go back to the three main asset classes that make up the All-Weather Portfolio: stocks, bonds, and commodities. During periods of rising economic growth, company profitability tends to increase and stocks do well. So do commodities: rising economic growth means increased demand for resources and higher commodity prices. During periods of falling economic growth, however, investors swap stocks for bonds as the latter offer a more dependable return. Central banks may also lower interest rates to help stimulate the economy – making existing bonds more attractive and also helping to push their prices up.
As for inflation, gold and commodities are real assets: physical assets with intrinsic value that become more popular when inflation is rising and eroding the extrinsic value of money. But when inflation is falling, bonds do well instead as the fixed amount of cash they offer investors becomes worth more. A $100 payout five years from now will be more valuable if the price of food and housing stays the same compared to a scenario where their prices double over that period.
So by having a diversified mix of these asset classes, and having each one contribute an equal amount to overall risk, the All-Weather Portfolio is designed to do well in all economic environments – at least in theory. That’s why it’s called “All-Weather”, after all…
The biggest advantage of the All-Weather Portfolio is probably this resilience in different economic environments. Another is that its passive strategy doesn’t require you to predict future economic conditions: remember Dalio’s principle of being open-minded and accepting the fact that we don’t know what the future holds? It’s a buy-and-hold strategy that demands occasional rebalancing rather than frequent trading – again, reducing fees and protecting investors from their own worst enemy: themselves.
One of the All-Weather Portfolio’s drawbacks, though, is that it’s very US-focused – with no room for international stocks or bonds. And while the strategy has performed well over the long term, it’s occasionally experienced protracted stretches of underperformance – and has historically returned less than the S&P 500 index of the largest US stocks. Finally, as the savvier among you will have noticed, the portfolio has a very high allocation to bonds (55% in total) and may not perform well during a sustained period of rising interest rates. We’ll address these points in more detail next.
The takeaway: Dalio’s All-Weather Portfolio, constructed using risk parity weightings for certain stocks, bonds, and commodities, is designed to perform well in all economic environments.
Now that you know the logic behind the All-Weather Portfolio and what it contains, the natural follow-up question is: just how successful has it been?
Strategy performance tracker AllocateSmartly has compiled robust data on the portfolio’s historical performance, even projecting it back to 1970. While looking at this in isolation is all well and good, it’s more informative if we compare performance to a benchmark. And seeing as we’re particularly interested in the relative success of risk parity asset allocation, we’ll compare it to the basic 60/40 strategy that invests 60% in US stocks and 40% in US government bonds.
Measured over the past 50 years, the All-Weather Portfolio generated an average annual return of 9.5% – virtually identical to the 60/40 benchmark’s 9.6%. But it managed this while taking on significantly less risk. The All-Weather Portolio’s volatility – a measurement of the instability of an investment’s performance – was 7.9% over the same period, significantly lower than the 60/40 portfolio’s 9.8%. Taken together, this means that the All-Weather Portfolio generated a higher investment return per unit of risk.
Having said that, volatility can be a flawed measure of risk. That’s because the statistic, which is calculated as the standard deviation of investment returns, includes both upside volatility (higher returns than average) and downside volatility (lower returns than average). Investors should welcome upside volatility and be worried about downside volatility – but as a standalone measure, volatility doesn’t discriminate between the two.
So how else can we measure risk? One investor favorite, especially when assessing individual investment strategies, is maximum drawdown (MDD). This measures the largest peak-to-trough decline in the value of a portfolio, as illustrated below. Knowing the worst loss a strategy’s previously experienced can be telling: a 50% drawdown, after all, means your portfolio would have had to then double in value just to get back to where it was!
The All-Weather Portfolio’s MDD over the past half-century was a relatively modest 13%, resulting from a stretch of poor performance in the early Eighties. Significantly, that 13% MDD was less than half the 60/40 benchmark’s 30%. But as with all these backward-looking statistics, there’s nothing to stop the All-Weather Portfolio from experiencing a larger peak-to-trough loss of 13% in the future.
The last thing we’ll consider is the strategies’ comparative robustness. Over the entire 50-year period, the All-Weather Portfolio lost money in only six calendar years – with the largest annual loss occurring in 1994, when it lost 5%. In other words, the strategy made money 88% of the time – while the 60/40 benchmark only managed it in 80% of those years. Furthermore, the latter’s largest annual loss was 18% in 2008 – understandable, considering US stocks declined almost 40% that year. The All-Weather Portfolio, with its larger allocation to safe government bonds, actually ended the annus horribilis of 2008 up 3%.
It all sounds impressive – but what’s the catch? One of the main criticisms of the All-Weather Portfolio’s historical performance is much of its success came from riding the decades-long bond bull market. Recall that 55% of the portfolio is invested in bonds that have enjoyed a nice upwards run since 1980 – as can be seen in the graph below, which shows the yield of 30-year Treasury bonds (remember, bond prices move inversely to yields).
And this is important to consider when it comes to predicting the strategy’s future performance. Mathematically speaking, bond yields simply cannot go much lower. That means there’s a good chance that the solid returns bonds have brought investors over the past few decades won’t continue. And should there be a meaningful rise in bond yields, falling bond prices would dent the All-Weather Portfolio’s performance – although this could be partially offset elsewhere. For example, if bond yields climb due to stronger economic growth, then the portfolio’s stock allocation would likely do well. Alternatively, if bond yields climb due to rising inflation, the portfolio’s commodities allocation may do better. But no one can predict the overall result with any certainty – it’s just a risk you’re going to have to accept.
The other thing to mention is that the All Weather Portfolio is based on the theory that bonds and stocks are negatively correlated in the long term: if one does poorly, the other performs well. But should this relationship break down at some point in the future, then during times of turmoil the strategy could suffer a one-two punch from both its stock and bond investments…
The takeaway: The All-Weather Portfolio's historical risk-adjusted returns are impressive, but some put this down to it riding a decades-long bond bull market – which might not last forever.
According to Ray Dalio, keeping all of your cash in a savings account isn’t a smart decision. That’s thanks, of course, to inflation, which slowly erodes the value of your cash. And Dalio, like any investor, thinks a better approach is to invest your money in a diversified portfolio of assets that will increase in value faster than inflation.
“Know how to diversify into non-cash assets like stocks, bonds, and real estate. When you look at most portfolios, they have a very strong bias to do well in good times and bad in bad times.”
– Ray Dalio
As we’ve discussed in this Pack, Dalio’s solution to the problem of a portfolio that simply rises and falls in line with the overall market is to spread out and balance the risks of each component investment.
And those who like the sound of that advice can construct their own All-Weather Portfolio using easy-to-invest exchange-traded funds (ETFs). Only do this, of course, if you personally believe the All-Weather Portfolio is a good strategy and it makes sense for you – that it meets your needs and is in line with your risk tolerance. On that note, also make sure you fully understand the risks that come with any form of investing and those particular to this strategy, such as the high bond allocation discussed in the previous session.
Got it? Then listen up, US-based investors – the following ETFs broadly mimic the specific asset classes mentioned in Session Three:
Remember, we know what the weightings of each of these ETFs are in the All-Weather Portfolio: 40% in long-term Treasuries, 30% in US stocks, 15% in intermediate-term Treasuries, 7.5% in gold, and 7.5% in other commodities. To save you the legwork, we’ve calculated how you’d construct this portfolio if you wanted to allocate, say, $10,000 to the strategy.
How frequently should you rebalance the portfolio back to its intended weightings? Dalio recommends annually, and this is also how AllocateSmartly did it in their backtest when we discussed the strategy’s performance previously.
Most European investors will find it a bit trickier to access the US ETFs listed above. Some similar alternatives, however – all listed on the London Stock Exchange and priced in US dollars – are:
It’s as simple as that. The only other thing to bear in mind when constructing your own All-Weather Portfolio is the cost of doing so. First are your broker’s trading fees when buying and selling ETFs – although sticking to annual rebalancing should help minimize those trading costs. Second, the ETFs themselves carry a fee to cover their operating expenses. This expense ratio is expressed as a percentage of the fund’s assets: for example, an ETF with a 0.50% expense ratio will deduct half a percent of your investment on an annual basis.
With that caveat, you’re all set to follow in Ray Dalio’s footsteps and put his Principles into practice. Just be sure to take an umbrella if you’re headed out for an All-Weather round on the course…
🔹 Ray Dalio is a successful investor who sticks to a series of investment principles, including cause and effect relationships, riding long-term trends, diversification, and being radically open-minded.
🔹 Strategic asset allocation is a sensible investment strategy, albeit one which aims to divide cash rather than risk – and that's the problem Dalio’s risk parity approach seeks to solve.
🔹 Dalio’s All-Weather Portfolio, constructed using risk parity weightings for certain stocks, bonds, and commodities, is designed to perform well in all economic environments.
🔹 The All-Weather Portfolio's historical risk-adjusted returns are impressive, but some put this down to it riding a decades-long bond bull market – which might not last forever.
🔹 You can construct your own All-Weather Portfolio using simple ETFs if the strategy ticks your boxes, but make sure you’re aware of the risks and fees involved.
/3 • Your free quarterly content is about to expire. Uncover the biggest trends and opportunities. Subscribe now for 50%. Cancel anytime.