Balanced Asset Allocation: How to Profit in Any Economic Climate

Chapter 3The Fundamental Drivers of Asset Class Returns

Ray Dalio took his understanding of the relationships that exist between economic and market shifts to create a revolutionary new and better way to structure a portfolio. He called it All Weather because it is designed to perform well across economic environments. Those investment firms that adopted the concepts (and could not use the All Weather name because it was Bridgewater's) call their products risk parity. Regardless of what we call it, it is a simple and effective way to balance your portfolio so that it lowers risk without lowering returns, and I want you to understand it. It is an elegantly simple solution to an important problem.

My goal in this book is to describe this framework for building a mix of asset classes that can reasonably be expected to deliver stable returns through time. Volatility is obviously unavoidable, but an asset allocation that has a decent probability of experiencing an extended period of significant underperformance is unacceptable. A necessary prerequisite to constructing such an efficient allocation is an understanding of the key fundamental drivers that result in the returns that you see. A better appreciation of the source of asset class returns will provide the needed insight for assembling an optimal asset allocation and minimizing volatility over time. If you understand the source of returns and what factors make them volatile, you will be better positioned to appreciate how to ...