Community Questions: So What’s The Best Portfolio Anyway?

Community Questions: So What’s The Best Portfolio Anyway?
Stéphane Renevier, CFA

about 2 years ago5 mins

  • The Yale portfolio invests more in risky assets like stocks and real estate than the 60/40, while the all-weather aims to perform in any environment by being truly diversified.

  • The all-weather has been the clear winner since 2008, outperforming both approaches on risk-adjusted returns and suffering minimal losses along the way.

  • But you might still want to hold the Yale portfolio if you’re not comfortable with the all-weather’s heavy bond allocation, or if you want to bet on higher growth and inflation.

The Yale portfolio invests more in risky assets like stocks and real estate than the 60/40, while the all-weather aims to perform in any environment by being truly diversified.

The all-weather has been the clear winner since 2008, outperforming both approaches on risk-adjusted returns and suffering minimal losses along the way.

But you might still want to hold the Yale portfolio if you’re not comfortable with the all-weather’s heavy bond allocation, or if you want to bet on higher growth and inflation.

Just the other day, I dug into how you could switch up your potentially more traditional portfolio with the David Swenson-pioneered Yale portfolio. And since then, I’ve heard from a lot of you asking exactly how they stack up against one another. So here we go: the three most popular portfolios, how to implement them using exchange-traded funds, and which one comes out on top.

Candidate 1: The 60/40

The 60/40 is the benchmark to beat for asset allocation. It’s not only the approach most commonly used by institutional investors, it’s also proved really tough to beat over the long term. It consists of a 60% allocation to stocks, balanced with a 40% allocation to US treasury bonds (i.e. government bonds) to help diversify your risk.

Strengths: The 60/40 is straightforward to understand, implement, and monitor, and intermediate US treasury bonds have historically been one of the most efficient hedges against stock crashes.

Weaknesses: Stocks are clearly much more volatile than bonds and have a much bigger impact on the portfolio’s returns, which means they carry plenty of risk. The portfolio also doesn’t hold any inflation hedges.

You can find the ETFs I recommend using to implement the 60/40 below, selected based on liquidity, cheapness of fees, and construction methodologies. Note that I’ve used global stocks rather than US ones, as they provide additional diversification benefits and are supported by lower valuations. I’ve also included the tickers you can use if you want to replicate the backtest (the “implementation tickers” don’t go far enough back in time).

60/40 portfolio. Source: Finimize
60/40 portfolio. Source: Finimize

Candidate 2: The Yale Model

The retail-adapted Yale Model consists of a diversified exposure to “core assets” – i.e. those that don’t require an active approach to generate long-term positive returns. The portfolio invests in global stocks and US treasury bonds (like the 60/40 portfolio), but also real estate and treasury inflation-protected securities (TIPS) to add inflation protection.

Strengths: The Yale portfolio only allocates to assets with positive long-term returns, it’s (in theory) more diversified than the 60/40, and it hedges against inflation.

Weaknesses: It’s a high-risk portfolio, with 80% of its allocation dedicated to stocks and real estate. Plus, the diversification benefits may be more theoretical than practical, insofar as bonds make up a very small proportion of the portfolio, and real estate is only a good diversifier when markets are going up.

Yale portfolio. Source: Finimize
Yale portfolio. Source: Finimize

Candidate 3: The all-weather portfolio

Ray Dalio’s “all-weather” portfolio was created to perform in any environment. By holding assets that perform well when inflation and economic growth are either high or low, the portfolio is designed to perform in a broader range of environments than its 60/40 and Yale cousins.

The all-weather was one of the first approaches to be based on the concept of “risk parity”, which allocates based on expectations of risk rather than returns. Bonds, for example, receive a much higher weight because they’re a lot less risky than commodities or stocks. That means stocks don’t drive the majority of the portfolio’s risk like they do in the 60/40 or Yale portfolios: it’s rather split almost equally between stocks, commodities, and bonds.

Strengths: The risk-parity approach makes the all-weather portfolio much more diversified than its competitors, making it a great alternative for an uncertain future.

Weaknesses: The all-weather is at a higher risk of interest rate shocks than its competitors, given that it holds such a heavier weighting of bonds. Its smaller proportion of high-returning assets like stocks may also mean it may generate lower returns over the long term. And to truly achieve risk parity, you’d also need to make sure you rebalance frequently.

All-weather portfolio. Source: Finimize
All-weather portfolio. Source: Finimize

So which one’s best?

If you’d started with a $10,000 investment in 2008, the Yale model would’ve generated the highest returns of the three, even though it suffered the biggest losses during the global financial crisis. Thanks to its high exposure to inflation, it’s also performed particularly well recently, as stocks, real estate, and TIPS outperform government bonds.

Growth of $10'000. Source: Portfoliovizualiser
Growth of $10'000. Source: Portfoliovizualiser

But when you take a closer look, it’s the all-weather that comes out on top.

Performance summary. Source: Finimize
Performance summary. Source: Finimize

The all-weather came up 0.6% a year less than the Yale portfolio, but it also experienced significantly less volatility, meaning its risk-adjusted returns beat both its rivals hands down.

Adjusted for the same level of volatility as the Yale Model, the all-weather would’ve returned almost 10% a year (6.3% returns x 11.6% / 7.4% difference in volatilities). What’s perhaps even more impressive is how small its worst loss has been (-12%) compared to the other approaches ( -27% for the 60/40, and -40% for the Yale model), as well as how robust its performance was during both the global financial crisis and the Covid crash.

Is the all-weather for life, then?

It’s undoubtedly the clear winner, but there are a few reasons why you might still prefer to implement another approach.

First, past performance is, as you’ve heard before, “no guarantee of future performance”. The all-weather has benefited heavily from the long downtrend in interest rates, as well as from the overall strength of bonds (although, to be fair, the performance of stocks over that period might be even more exceptional, biasing the other results too). But with central banks poised to hike rates repeatedly over the next decade, there could be challenges ahead for both. Keep in mind too that our backtest only started in 2008, which may not be long enough to draw conclusions about how it would perform in other economic environments. We’ve only experienced highly supportive monetary policy since then, after all.

Second, it’s important that you implement an approach you’re comfortable with. If investing 50% of your portfolio in bonds makes you nervous, you’re unlikely to stick to it when more challenging times arrive. And finally, your choice depends on your economic outlook. If you believe that, say, we’re about to see strong growth and higher inflation over the next decade, it might make sense to go with a model that outperforms in that environment – namely the Yale model.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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