A lot can happen over the decades. There will be recessions, bear markets, bull markets, political upheaval, possibly even depressions. Do we up-end our asset allocation every time some pundit on CNBC is screaming at us? Certainly not. This post reveals two ways to create a portfolio that performs well in all conditions.
One of the critical components of our investment philosophy is to set it and forget it. When you are always buying and selling based on the prevailing economic conditions, you’re practicing the exact opposite of set it and forget it investing.
We need to create a portfolio that performs well in all conditions. Well, we don’t need to create this portfolio because someone has done it for us.
And that someone is not just anyone. He happens to be Bridgewater Associates hedge fund manager Ray Dalio, one of history’s legendary investors.
Ray Dalio created what is known as the
But Ray Dalio’s
What is the
LMM is a huge Ray Dalio fan. Can the
A Recession-Proof Portfolio?
What we do know is that we are in the part of the cycle in which the central banks’ getting monetary policy right is difficult and that this time around the balancing act will be especially difficult (given all the stimulation into capacity constraints and given the long duration of assets and a number of other factors) so that the risks of a recession in the next 18-24 months are rising.
But some fear remains due to corporations still not spending on things like equipment, software, commercial buildings, factories, and mines.
Bloomberg Economic has created a model to predict the odds of a recession in America in the next year and gives it a 26% chance of happening.
The model uses a range of data, including economic conditions, financial markets, and gauges of underlying stress.
So while the predictions are not quite as dire as they were, it’s still a scary time for a lot of investors.
No one wants to lose money in the stock market, but we can’t become too risk-averse because doing so won’t allow our money to grow at the rate we need it to for a comfortable retirement.
What we need is an investment strategy with a permanent portfolio of investments that can weather anything the economy throws at it.
And add to our wish list, an investment strategy that doesn’t depend on trying to time the market.
Two Main Portfolio Ingredients
All of this sounds like a tall order, but it’s pretty simple. There are two main ingredients you need to create a portfolio that can roll with the punches, that can reduce our risk while not diminishing our returns; diversification and risk-weighted return.
We’ve talked about diversification ad nauseam, but we’re going to talk about it some more because it’s so critical for individual investors.
Being diversified means nothing more than spreading your investment dollars out across various asset classes and different sectors within those asset classes.
The trick is to take risks and be paid for taking those risks. To take a diversified basket of risks in a portfolio.Tweet This
If we’re talking about
Put simply, don’t out all of your eggs in one basket. Low-cost
Risk-weighted return is how much return your investment has made relative to the amount of risk that investment has taken over a given period.
If two investments have the same return over a given period, the investment with the lowest risk will have the better risk-weighted return.
Here’s an example:
Vanguard’s Total Stock Market Fund
- Average Annual Return +9.4%
- Deepest Drawdown (2008) -49.3%
- Average Annual Return +7.94%
- Deepest Drawdown (2008) -10.8%
You can see the peril of chasing returns.
TSMF (Total Stock Market Fund) had a mere 2% earned per year advantage over
Get our best strategies, tools, and support sent straight to your inbox.
While Dalio is agnostic about the stock market, the
Golden Butterflyskews toward prosperity. And for a good reason. Over time, there have been more times of economic growth than times of decline and recession.
This is what a
We want our retirement not only to earn us money but help make sure we have a world worth retiring in. Not coincidentally, the SRI Large Cap fund JUST outperforms VTI.
You’ll notice we use JUST, which is our Socially Responsible Investing replacement for Vanguard’s Total Stock Market fund, VTI.
Here’s a link to the classic version if you’d prefer that one:
Previously we had recommended SPDR’s GLD here, but IAU is a very similar fund. It’s virtually identical, stored gold bullion, but IAU has a lower expense ratio, 0.40%, and 0.25%, respectively.
|Weightings||Portfolio Components||Asset Class|
|20%||U.S. Large-Cap Equity||Stock|
|20%||U.S. Small-Cap Value||Stock|
|20%||U.S. Long-Term Treasuries||Bond|
|20%||U.S. Short-Term Treasuries||Bond|
Do These Assets Make Good Investments?
We know that the
Most of those in the world of personal finance don’t recommend gold as an investment. It’s the kind of thing you associate with Doomsday preppers.
Long term treasuries are volatile for bonds and are at risk of losing significant value in the future. Small-cap value is controversial, and there is much debate about its future outlook. With current rates, short-term treasuries seem like a waste of your investing dollars.
So! Four out of the five assets that make up the
You Can’t Argue With Results
It’s worst year saw a loss of only 11%, and the longest drawdown period was just two years. The
Not only was the
Golden Butterflygreat for accumulation overall timeframes, but it was also vastly superior in retirement with 40-year Safe and Perpetual withdrawal rates nearly 2%(!) higher than the stock market equivalent.
All Weather Portfolio
We explained who Ray Dalio is, but why did he create a set it and forget it portfolio? He makes billions of dollars
Well, after realizing that he had made and would continue to make more money than he could spend in a billion lifetimes, Dalio knew he needed to set up a trust.
Since he wouldn’t be around to oversee the trust, he needed to create a portfolio that would make money in all market conditions regardless of interest rates, deflation, what new pandemic is threatening our shores, or who the POTUS is.
According to Dalio, growth and inflation are all that matters. They are either up or down, and there are various combinations.
Growth is up; inflation is down. Growth is down, inflation is up, etc.
Dalio broke this up into four quadrants and designed a portfolio that would perform well in each.
He used back-testing to simulate his strategy using historical data to see the results and analyze the risk and profitability.
The portfolio also had to hold up against start date sensitivity, meaning to be successful; it’s not necessary to try and time the market.
|Weightings||Portfolio Components||Asset Class|
|30%||Total U.S. Stock Market||Stock|
Whenever you start investing with the All-Weather Portfolio, it won’t impact the performance.
This is what the
Golden Butterfly and the 4% Rule
Is your retirement plan to use the 4% rule? The 4% rule states that if you only withdraw 4% of your invested money each year to live on, your money will not run out for at least 30 years.
A lot of experts feel the 4% rule is outdated and should now be 3.5% or less.
With TSMF, you can only afford to withdraw 3.5%, but
But in terms of the amount of money you have to live on each year of your retirement, the difference is significant.
If you have $1 million for retirement, the TSMF will give you $35,000 per year, but the
We Haven’t Been Holding Out
We haven’t answered because he wasn’t sure! He has so much money sitting in an opportunity fund, making jack interest because he hadn’t yet decided what to do.
That’s how this episode was born. He was researching his options and started looking into different stock portfolios.
If you’ve listened for any length of time, you know Andrew is a big Ray Dalio fan and for a good reason. The guy has some of the highest returns in the business.
So it came as a surprise to even Andrew when he found himself leaning more toward the
But that’s the plan. While we are expecting a recession, the historical data doesn’t lie. Our economy experiences more periods of economic growth than periods of recession.
All Weather was built for well, all weather. But we have more good weather than bad, so in the battle of the portfolios,
Philoso Rapper: A Belgium Style Ale.
Double Dry Hopped Coriolis Effect: A New Zeland Style IPA