December 19, 2022

What is an ‘all-weather’ portfolio?

Making short-term,tactical asset allocation decisions is something that we’ve rarely seen anyone able to do this with consistent success over the long term

Making short-term, tactical asset allocation decisions is something that we’ve rarely seen anyone able to do this with consistent success over the long term. Therefore, asset allocations should be set with the long-term in mind.

Economic and market conditions are uncertain and always changing, so it’s important that your investment portfolio contains a mix of stocks and bonds that work well in different scenarios. This means that if one fund performs poorly, another fund should be able to perform well – and that’s true diversification. This concept was developed by Ray Dalio, a billionaire investor and founder of Bridgewater Associates, the largest hedge fund in the world.

An all-weather portfolio is a portfolio that’s constructed to perform well, despite changing market conditions. The diagram below shows which asset classes have historically performed well in different economic environments, although this may not always be the case, and some assets will perform better than others in each scenario.

How does it work?

Since an all-weather portfolio depends on the relationship between asset classes and changing market environments, a combination of long-term and intermediate bonds, stocks, commodities (examples: metals, energy, and agriculture), and gold should allow investors to continue realising steady returns while minimising losses, regardless of the market environment.

So in reality, the stock segment of the portfolio should do well when markets rise. And when markets fall, investors would be compensated by their intermediate-term bonds, commodities, and gold. This isn’t the case now as interest rates across the world have been rising. And markets don’t like it when interest rates rise. It makes companies’ debt more expensive, means they often invest less, and consumers tend to buy fewer of their products and services. Bonds also tend to fall when interest rates go up, although yields also rise, so from an income perspective they can become more attractive.

Why does it contain many asset classes?

It’s all about diversification. Diversified portfolios can produce excellent long-term returns while reducing the risks of being too heavily invested in a single area or fund. True diversification means not everything in a portfolio will be doing well at the same time. It allows portfolios to smooth return and reduce drawdowns. Having said that, over-diversification is not desirable as it can ‘water-down’ performance, make ongoing oversight more challenging and add to costs.

Bottom line

Investors who want to avoid buying or selling stocks at the wrong time could choose to invest in an all-weather portfolio. When investing biases kick in, it can be very easy to sell in a panic, which could result in losses. An all-weather portfolio effectively bypasses that since you’re sticking with the same asset allocation over time. By implementing a handful of mutual funds and Exchange Traded Funds (ETFs), you can create an all-weather portfolio. This strategy could help you manage risk over the long-term.

However, no investment strategy is 100% guaranteed and an all-weather portfolio is no exception to that. While it can offer several benefits, there are some cons to keep in mind. While the stock portion of the portfolio can do well during periods of rising economic growth, the overall portfolio may underperform if stock allocation is less than bond allocation. Someone who’s investing majority of their portfolio in stocks, on the other hand, is likely to see bigger returns during economic boom periods.

Interest rate risk is something else to consider when allocating a large amount of a portfolio to bonds. Bond yields and interest rates have an inverse relationship. Higher inflation risk can also be problematic and may result in an underperformance. Rising inflation can cause purchasing power to shrink if the portfolio underperforms.

Our approach

We believe the best way to achieve your long-term financial goals is to diversify in a way that a portfolio can perform consistently during periods of economic growth as well as periods of economic stagnation. Understanding how an all-weather portfolio works can help you decide if it’s right for you.

To find out more about your investment options and portfolios, you can contact Skybound Wealth Management who will help you invest in a portfolio that could meet your financial needs throughout a variety of economic circumstances.

Written By
Nikita Maxwell
Investment Analyst

Past performance is not a guide to future returns. Investment in securities involves the risk of loss and the advice herein cannot be construed as a guarantee that future performance will be reflective of past returns.

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