Advancing Ray Dalio’s All-Weather Portfolio
For those who do not know Ray Dalio, he is essentially the founder of Bridgewater Associates, the largest hedge fund in the world, managing $130 billion globally. The fund is renowned for making money in both good and bad economic conditions. One of Dalio’s portfolio models is the All-Weather portfolio. A well-diversified low-risk investment strategy crafted to thrive in all economic conditions, growth or decline, inflation, or stability. The portfolio produced an average annual return of 6.69% over the past 25 years with a maximum drawdown of 20%. In contrast, the S&P 500 (SPY) index produced an annual return of 9.9% over the same timeframe yet had a drawdown of 50% (which took place during the 2008 financial crisis.) Although the SPY produced higher returns Dalio’s innovative portfolio provided similar returns for much less risk, drawdown and increases diversification.
With advancements in AI and the vast sea of information that now exists online, I was able to take his all-weather portfolio and (through strenuous backtesting and risk evaluations) find ways to improve it through modifying allocations and swapping ETFs to not only gain a better return but also one that comes with less risk.
Allocations of the All-Weather Portfolio and the Newly Devised Model
Ray Dalio: 40% long-term treasury bonds, 15% short-term treasury bonds 30% stocks, 7.5% gold and 7.5% commodities.
New Model: 20% large-cap growth stocks, 20% healthcare stocks, 20% short-term corporate bonds, 10% short-term treasury bonds 10% long-term treasury bonds and 20% gold. The image below can help us visualize.
What the New Model Changes and Why
If you are interested, I will talk about the philosophy of the new model, if not just skip to the portfolio's performance. First, the biggest change would be the reduced position in bonds. These are most likely going to be the portfolios underperformers anyway and the economy spends most of its time in expansion than recessions so more should be allocated to equities so we can benefit from the growth. However, 40% of the portfolio is still invested in bonds, not just government bonds but also corporate bonds too. This is for further diversification plus corporate bonds produce higher yields. The new model has 2 types of treasury bonds short and long term but if you replaced those 2 with just BND (U.S total bond market ETF) you would still get similar results.
Next, equities have been increased but instead of just investing in the VTI (total U.S stock market ETF) the model is exposed to 2 stock ETFs. XLV (healthcare) and VUG or MGK (large-cap growth ETFs.) This is done because these 2 categories have outperformed the market over the last 20 years and have more favorable risk to reward ratios. Below displays the risk analysis. The sharpe ratio is a mathematical equation that basically measures the risk to reward ratios, the higher the sharpe ratio the better the investment is on a risk-adjusted basis. The Alpha is the measure of a return compared to the overall market, an alpha of 3 for example means that on average you did 3% better in a year than the market, so the higher the better.
As we can see, technology, health care and large growth ETFs do better than the markets (alpha) and have better risk-adjusted rewards (sharpe ratio.) That is why we have large-cap growth and healthcare ETFs in the portfolio (the large-cap ETF has a large amount of technology stock within it.) Healthcare is specifically great because it has returns that match the S&P index (SPY) but with less risk and volatility, it is an offensive and defensive sector at the same time.
Last I removed broad commodities and replaced it with the most well-known commodity gold. The intrinsic value of many commodities like oil, sugar, wheat or coffee will not rise in value that much (or may even decline) as farming technologies advance. For example, one would think that the oil sector would be a great place to invest in as energy is so essential for modern life, but because of advancements in technology (like more gas-efficient cars, appliances or the development of alternative energies) that has mitigated its need. It is still an essential commodity, but the intrinsic value of oil itself will not grow by a large degree. Another example is sugar, this commodity was once known as a “fine luxury spice” a few hundred years ago but with advancements in agricultural technology, it is now just a bulk commodity that we put in everything. There are not many alternatives to gold, and you can’t just grow even with the best technology, that is why it accounts for 20% of the new portfolio.
Portfolio Performance
If we simulated the portfolio back to 1999 the average annual return would be about 7.9%. The portfolio has made money in 19 out of the past 25 years, and 2 of the losing years were beneath 1%. In other words, the portfolio has a 76% probability of making money in a given year. The visual below compares its returns to the SPY.
As you can see, the average return for just investing in the SPY is slightly higher but your yearly drawdowns are much more severe. The dot com bubble in 2000–2002 saw a total loss of 43% while the new model saw a total loss of only 2.96%. In the 2008 financial crisis, the markets saw a decline of 36.8% but the new model saw a restrained loss of 10.7%.
Maximum Possible Downside/Drawdowns
The tables presented display lots of information for the nerds out there but the primary thing I want to show you is the maximum possible drawdown percentage the portfolio has ever experienced. We can see that the SPY at one point did have a 50.8% drawdown (during November 2007-Febuary 2009) in contrast the new model only had an 18% drop (highlighted).
Thus, this portfolio is perfect for someone who wants to take less risk and preserve capital all while getting a similar rate of return to the overall market.
How This Compares to Dalio’s All Weather Portfolio
The table below shows that the portfolios are similar, but the new model does outperform Dalio 17 out of the past 25 years (highlighted in yellow) and the average annual rate of return is slightly higher.
Portfolio Risk-to-Reward Analysis
We will use the same 2 metrics (sharpe ratio and alpha) to see the risk to reward ratios. Remember the SPY had a sharpe ratio of 0.70 and an alpha of 0 (because the SPY is the market), the new model does slightly better with a sharpe ratio of 0.78. The simulations do not have data on the alpha however this metric does favor the SPY instead as when the markets do well the new portfolio only gets a fraction of the benefits because 40% of the portfolio is in bonds and another 20% in gold, and both have low correlations to the markets.
When simulating the portfolio in lazyportfolioetf.com it uses its database to recommend more efficient portfolios, however with this new model, we get the message below.
Benefits of the New All-Weather Portfolio
- Smoother consistent performance across all market conditions.
- MUCH lower drawdowns in economic corrections and crashes.
- Lower correlation, many assets are uncorrelated to each other, and to the overall stock market. The graph below shows that the more uncorrelated assets you have, the lower you are likely to see a loss.
- Diversification in gold and bonds (both corporate and government.)
- Great at wealth preservation especially in the long term.
Cons of the New All-Weather Portfolio
- Slightly lower returns than the SPY.
- Very U.S focused, both the stocks and bonds are from United States issuers, there is not much diversification from other countries. However, the U.S markets are currently the largest in the world and have historically had the highest, most stable returns.
Constructing the New All-Weather Portfolio With ETFs.
The list shows the exact allocation percentage and the best ETFs for this portfolio, they are the best because they have the lowest fees and have millions of dollars of assets under management.
MGK: mega-cap growth or VUG large-cap growth 20%
XLV: healthcare 20%
AAAU: gold 20%
VCSH: short term corporate bond 20%
SHY: short-term treasury bond 10%
TLT: Long-term treasury bond 10%
Conclusion
The hypothetical chart shows the growth of a $10,000 investment with a $50 monthly contribution through 40 years with a 7.9% return. There will be bumps along the way and the graph does not show that, but it would take about 9 years to double your original funds.
The refined portfolio gives us a great place to invest our funds with little risk and sizable annual growth. Once again it has a 76% probability of positive growth in year with the average return of 7.9%. This investment also allows you to sleep well knowing that your portfolio will do good in all economic environments even in the really bad economic crashes like the ones witnessed in 2001 and 2008. Yes, there are investments with higher returns like the SPY or the Nasdaq index for example, but the point of this model is to drastically minimize drawdowns/volatility while maximizing returns. I would argue that this portfolio has the best possible risk to reward ratio for your hard-earned money.
“Investing is a balance between taking risks and managing them.” — Ray Dalio
