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currently there are over 162 million Americans who are investing in the stock market and this means that over 62% of the total American adult population can be considered an investor this means that there are millions of different risk profiles millions of different investment strategies but the interesting thing is that all investors share one common objective and this common objective is very well explained by this quote by monish pabai where he says that minimizing downside risk while maximizing the upside is a powerful Concept in other words we're all looking to make as much money as possible while taking on the lowest risk that we can this is why so many different investment vehicles such as ETFs indices or other type of funds have been growing in popularity recently because they offer you a way to get a very positive return while minimizing your risk or at least your risk compared to the rest of the population and that actually makes us feel safe and makes us feel good about ourselves in history there is perhaps one rible example of a portfolio that has actually managed to obtain a very positive return while minimizing risk and this portfolio was created by Ray Doo's Bridgewater this fund was particularly looking for a portfolio which would Faire positively in any kind of economic climate because what they found is that yes of course equities outperformed when you were in an economic boom but they underperformed when you were in an economic recession so the way they decided to actually tackle this problem was to create an environmental box framework which is the one you're seeing on your screen this divides investments into different economic environments that may be present nowadays where we have growth and inflation and then the market expectations whether the market believes that growth or inflation will be rising and whether the market believes that growth or inflation will be falling their objective was to create a portfolio that had all of its risk spread out evenly into these different boxes and that way you have created yourself an all weather portfolio so they started listing the different asset classes that outperforms in the different economic climates so when the market is expecting growth to rise usually equities Commodities corporate credit and Emerging Market credit are the asset classes that are outperforming however when the market expects growth to be falling usually nominal bonds and inflation linked bonds are the ones who tend to outperform same happens with inflation when the market believes that inflation will be rising inflation link bonds Commodities and emerging credit will be booming but when the market believes that inflation will be falling equities and bonds are the ones which will be outperforming and by using this framework they actually managed to create one of the most famous portfolios that exist up to today which is the old weather portfolio but before we move on to its composition we have to analyze its performance and volatility to see if it actually manages to return a proper return while minimizing its risk over here we conducted a back test analysis which basically consists of seeing how these portfolios behaved in the past and comparing the all weather portfolio against the S&P 500 which is normally used as the Benchmark for investing we can see that of course the all weather portfolio underperformed the annualized growth rate of the S&P 500 with a 7% cumulative return versus an 11% cumulative return and that's a big difference when you compound it Over time however when we look at the maximum draw down by strategy the allweather portfolio only had a Max draw down of 177% while the S&P 500 had a Max draw down of 60% now the Max draw down basically indicates the maximum drop in value from the recent all-time highs for example if the maximum alltime high of the S&P 500 was $6,000 and it fell to 3,000 at one point their Max draw down would be a 50% because the total value dropped from the alltime highs was a 50% so when you compare these side by side this is not about prioritizing return it's about prioritizing risk adjusted return which as we can see the all weather portfolio is clearly ahead but how can this portfolio actually manage to create such decent returns with such low volatility where we can see it over here now this is usually created by using a mix of different ETFs which of course you can find Down Below in the slide if you want to recreate it you usually have 30% of stocks where you use the S&P 500 you use 15% of midterm bonds 40% of long-term bonds 7.5% of gold and 7.5% of other Commodities of course this is not fixed you can use whichever allocation you want this is just the one that mathematically worked for ralio but if you prefer to take a lot more risk what you can do is decrease the percentage of long-term bonds or midterm bonds that you would be taking on and increase your portion allocated to the S&P 500 that way possibly your returns would be increasing but your Max draw down will also be increasing this is just a game of playing with the percentages looking at the back test analysis and seeing what works best for your risk Prof profile but why exactly did rayal include these four different asset classes and I say four because we're going to speak about long-term and Midterm Bonds in a very similar way well first of all you need stocks because stocks are one of the best performing asset classes in history we can look at this information from 2002 to 2021 and this is the annualized return where the S&P 500 outperforms pretty much every other asset class we can see that of course gold is closely behind with a 7.8% bonds having a 4.3% and Commodities a mere 1.8% we have to listen to what Charlie Monger says which is that stocks with their compounding growth often reward patient investors more handsomely than bonds or Commodities so although stocks may be a lot riskier than other asset classes we can't ignore them and invest in other things because you would be missing out on a lot of returns if you actually left them out from your portfolio but then if bonds perform so poorly why do we have such a big percentage of allocation into that asset class well this is mainly in order to reduce your volatility your exposure and improve your Max draw down because over here we can compare the maximum draw down between Commodities gold equities and bonds and we can see that bonds are way at the bottom but there is a big difference between bonds and every other asset class and over here we have the split between what we consider long-term bonds which are us 30-year bonds and Midterm bonds which are the US 10-year bonds now it's good to diversify between your bonds because we can see that even here there is a big difference in the Max draw down and of course the returns that these offer so the main reason why we have to have Bonds in this portfolio is explained by Peter Lynch bonds are the place to be if you're worried about the volatility in the stock market in other words if you want to sleep well at night and you want to know your capital is protected you should have Bonds in your portfolio and that's why they're in the old weather portfolio and finally we saw that Commodities have been one of the worst performers and have the highest maximum draw down out of all asset classes why should we include them well first of all it's key to note that they're only a small portion of our portfolio however when we look at their correlation to inflation we can see that gold and commodities are the only asset classes positively correlated to inflation meaning that when there are periods of high inflation such as from 2021 all the way up to now gold and commodities tend to shine above all other asset classes so as Peter Schiff said in times of economic uncertainty gold and commodities act as a store of value and a hedge against currency devaluation so you're using this particularly to hedge against bonds which perform terribly when there is rising inflation over here we have a very quick summary to compare the different four asset classes and show why they're actually needed first of all it's very key to note that there are very low correlation between these for asset classes which is overall what you need in a diversified portfolio so we can see that the average annual return the leaders over here are equities and gold when it comes to maximum draw down the clear leader is bonds and it's the main reason why included in the portfolio and we can see that when it comes to correlation to inflation this also allows us to have gold and commodities to hedge when we look at the best economic period where these different asset classes shine we can see that equities and commodities shine during economic expansions and bonds and gold usually shine during economic slowdowns now of course one of the main reasons why bonds have such a low return is because in the past 10 20 years an economic recession has been extremely rare finally we also have a relative risk level where we can see of course that equities are the highest and bonds are the lowest so my investing strategy currently is that I will still be buying individual stocks because I'm currently young I have a moderate risk profile and overall I have the time right now to keep doing this but over the long term in 10 15 years I do see myself actually starting a position or a separate portfolio where I have the all weather portfolio in order to have more stability and a safer portfolio but regardless of what your investment strategy is you have to remember that when investing you should keep a long-term Horizon because as Warren Buffett said our favorite holding period is forever so thank you for watching as always this has been the cash flow compounder join the free patreon forra content and I'll see you in the next one
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