The Low-Risk “All-Weather” Portfolio

Creating a properly diversified portfolio can be a difficult proposition, especially when interest rates have remained historically low for some time. Now, suppose an investor is interested in that same diversified portfolio but would also like it to outperform in down markets. That’s certainly a tall order.

Exchange-traded funds (ETFs) are one way to provide that diversification while reducing costs compared to other investments. Unlike mutual funds, ETFs will trade like stocks on an exchange and will fluctuate throughout the day. Their lower-than-mutual-fund fee structures make them attractive to investors. ETFs can track nearly any market, from commodities to bonds and stocks, providing extra diversification.

Ray Dalio, founder of the investment firm Bridgewater Associates (and one of Time Magazine’s top 100 most influential people in 2012), created a portfolio that can weather almost any storm – because, as he puts it, you never know the environment your portfolio will be facing. In an interview that appeared in Tony Robbins’ book MONEY Master the Game: 7 Simple Stapes to Financial Freedom, Dalio suggested the following allocation for his all-weather strategy:

• 30% Stocks
• 40% Long-Term Bonds
• 15% Intermediate-Term Bonds
• 7.5% Gold
• 7.5% Commodities

Amazingly, over a 30-year period that portfolio would have earned 9.7% annually and would have made money 86% of the time. The correlation between all these investments and their risk strategy is that no one asset class holds a majority of the investments or asset types. In other words, even with bonds holding 55% of the portfolio that still leaves a big chunk of investments to seek out higher risk-reward outcomes with different investments. Bonds are there to smooth out the rough equity years but will not be a huge drag on the rest of the portfolio during bull markets.

As mentioned earlier, there are a number of ETFs to satisfy the investor interested in a diversified portfolio. For example SPDR ETFs use the S&P 500 Index as their benchmark. The SPDR S&P 500 ETF (SPY A), for example, has top holdings such as Apple (AAPL), Microsoft (MSFT), Exxon Mobile (XOM), General Electric (GE) and Johnson & Johnson (JNJ). Since its inception in 1993, the ETF has earned an annualized return of 8.75%. Over the past three years it has annualized 12.27%. These returns are as of September 30, 2015.

Vanguard also has a number of diversifying ETFs. Its FTSE Emerging Markets Index ETF (VEE) tracks the FTSE Emerging Markets Index. The part of the portfolio with the most holdings is delegated to financial services, with 30.60%, and technology at 11.90%. Geographically, the bulk of its holdings are in China, Taiwan and India. Over the past three years, this ETF has earned 4.98%, but over the past year has lost 3.09% due to the severe fluctuations in the market. These returns are as of September 30, 2015.

These two ETFs can be used to gain exposure to the equity section of the all-weather portfolio.

• To gain exposure to gold, an ETF such as the SPDR Gold Shares (GLD A-) can be used.

• Similarly, for commodity exposure, the iPath Bloomberg Commodity Index Total Return ETN (DJP A-) can be used.

• For long-term bond exposure, the iShares 20+ Year Treasury Bond ETF (TLT B+) can be used.

• For intermediate-term bond exposure, Schwab Intermediate-Term US Treasury ETF (SCHR A) can be used.

• Or you can also have exposure to corporate bonds, instead of these “safe havens”.

More ETFs can be found in our screener, where you can pick your own gold, commodity, bond, and equity exposure using ETFs.

One thing to consider when diversifying a portfolio and using ETFs versus mutual funds is that because they can be traded on a daily basis, they are not the average “passive” investment. They are more convenient, liquid and have lower costs than mutual funds.

Overall, there are different ways investors can diversify their portfolios – with straight equities, mutual funds, ETFs and a combination of any of those. The trick is to ensure you know what you want out of your investment. ETFs, because of their stock-like characteristics but low costs, create a nice balance for investors seeking to achieve lower-risk, high-reward portfolios. Simple “all-weather” strategies like the one mentioned above can help sustain and grow assets in the long run while at the same time keep afloat in down markets.

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