Week 46 Day 5: The All-Weather Portfolio: Prepared for Any Season

The All-Weather portfolio: 30% VTI (stocks), 40% TLT (long-term Treasury bonds), 15% IEI (intermediate Treasury bonds), 7.5% GLD (gold), 7.5% DJP (commodities). Historical return: approximately 7%/year. Maximum drawdown: approximately -12% (vs. -50%+ for 100% stocks). The portfolio barely blinked during 2008 (-3.5%). The trade-off: lower returns in strong stock markets.

The four seasons framework: (1) Rising growth: stocks do well (30% VTI). (2) Falling growth (recession): long-term bonds do well (40% TLT). (3) Rising inflation: commodities and gold do well (15% GLD/DJP). (4) Falling inflation (deflation): long-term bonds do well (40% TLT again). The heavy bond allocation (55% total) makes this portfolio very smooth but caps the upside. Performance comparison (2005-2024): All-Weather: approximately 7.0%/year, max drawdown -12%. 60/40 VTI/BND: approximately 8.3%/year, max drawdown -25%. 100% VTI: approximately 10%/year, max drawdown -50%. The All-Weather portfolio is for investors who value stability ABOVE returns. It is psychologically easier to hold: a 12% maximum drawdown is barely noticeable compared to a 50% crash. Who should use this: (a) Retirees who need stable portfolio value. (b) Extremely risk-averse investors. (c) Investors who have historically sold during crashes (the smoother ride prevents behavioral errors). (d) As a portion of a larger portfolio (e.g., 50% All-Weather + 50% VTI for a blended approach). Limitations: (a) 2022 was the worst year in decades for All-Weather: both stocks AND bonds fell simultaneously (rare). The portfolio lost approximately 20%. This was a 'four-season storm' that challenged the fundamental assumption that stocks and bonds are negatively correlated. (b) The heavy bond allocation means underperformance during strong stock markets (opportunity cost).

The All-Weather portfolio is a simplified implementation of Bridgewater Associates' risk parity approach. Risk parity allocates portfolio weight based on RISK CONTRIBUTION rather than capital allocation. In a traditional 60/40 portfolio, stocks contribute approximately 90% of the risk (because stocks are approximately 4x more volatile than bonds). The 60/40 portfolio is effectively a stocks-with-some-bonds portfolio. Risk parity equalizes risk contribution: each asset class contributes approximately 25% of portfolio risk. Because bonds are less volatile, they require a LARGER capital allocation to contribute equal risk, resulting in the approximately 55% bond allocation. Bridgewater's full Risk Parity approach uses leverage to amplify the low-volatility bond allocation and achieve equity-like returns with bond-like volatility. The retail version (All-Weather) does not use leverage and therefore accepts lower returns in exchange for lower volatility. The 2022 performance challenged risk parity: the correlation between stocks and bonds turned strongly positive (both fell together), violating the negative-correlation assumption that underpins the strategy. This regime (positive stock-bond correlation during inflationary periods) was common pre-1990s but rare in the 2000-2020 period that most backtests cover. If the positive correlation regime persists (due to structurally higher inflation), the All-Weather portfolio's diversification benefit will be reduced. The gold and commodities allocations provide additional diversification that is independent of the stock-bond correlation, partially mitigating this risk.