Investing

Dividend investing has become an obsession. Books have been written about. YouTube channels have been dedicated to it. Some have an almost cult-like attachment to the Dividend Aristocrats.

Many investors flock to dividend ETFs because of their higher yields. In contrast, I like dividend ETFs for their lower valuation metrics. Given the high valuations in the S&P 500, an argument can be made to add a dividend ETF or mutual fund as a way to bring down the P/E ratio of a portfolio.

In that light, we’ll look at 5 excellent dividend ETFs to consider. We dive into each to understand how the portfolio is constructed and how each has performed over the past decade. We also look at three dividend ETFs we should avoid.

What is a Dividend ETF

Virtually all stock ETFs generate dividends. Even an S&P 500 index fund has a yield (about 1.2% for those keeping score at home). The payment of a dividend, by itself, does not qualify a fund as a dividend ETF. Rather, a dividend ETF is a fund that invests in companies that pay a higher than average dividend yield.

Such a broad definition leaves room for a wide variety of investment strategies. Some funds focus on companies with high yields, while others focus on companies that are growing their dividends at a high rate. Still other ETFs limit their portfolios to companies that have increased their dividends each year for a set number of years (typically 5 to 20).

While each of these funds are rightly described as dividend funds, they couldn’t be more different.

How to Compare Dividend ETFs

To compare one dividend ETF with another, here are the factors I consider:

Dividend Yield: As I’ve stated repeatedly on my YouTube channel, total return should be an investor’s north star. That said, in evaluating a dividend ETF, the yield is an important factor. Here I’m more concerned with yields that are too high than too low. I’ve yet to find a dividend fund with yields 3x or more the market’s average that have performed well over long periods of time.

Dividend Growth: Beyond yield, look at how quickly the companies in a fund grow their dividends. Such companies often offer the best combination of returns–a dividend along with excellent growth prospects.

Dividend Stability: A high yield doesn’t help an investor if the company paying it is on shaky ground. Here I want to understand what percentage of a companies profits go to paying the dividend (i.e., Payout Ratio). A red flag would be a company who is borrowing money to meet the dividend expected by investors.

Fundamental Factors: One of the benefits of a dividend ETF is that a value approach to investing. Many dividend ETFs have P/E and P/B ratios well below the market average.

Expense Ratio: As with any investment, we need to understand the costs. An expense ratio above about 15 basis points requires scrutiny.

5 Best Dividend ETFs

1. Schwab US Dividend Equity ETF (SCHD)

The Schwab U.S. Dividend Equity ETF (SCHD) easily takes the #1 spot on my list. It has a yield about 2x the market’s average. It requires companies to have 10 consecutive years of dividend payments to make the cut. And most importantly, it has relatively low valuations. It’s P/E ratio is about 19. While that’s still high based on historical standards, it’s well below the valuations of the S&P 500 (currently more than 30).

The fund tracks the Dow Jones U.S. Dividend 100 index. The index screens companies based on the following criteria:

• Minimum 10 consecutive years of dividend payments
• Minimum float-adjusted market capitalization of US $500 million
• Minimum three-month ADVT of US $2 million

What makes SCHD a winner, however, is the fundamental analysis used in stock selection. Factors include return on equity, free cash flow to debt and the five-year dividend growth rate. The result is a fund that has performed well over the years.

Tracking Index: Dow Jones U.S. Dividend 100 Index
TTM Yield: 2.82%
Dividend History: 10 consecutive years of dividends
Expense Ratio: 0.060%
AUM: $27.8 billion

2. Vanguard Dividend Appreciation ETF (VIG)

The Vanguard Dividend Appreciation ETF (VIG) tracks the S&P U.S. Dividend Growers Index. Unlike SCHD and the Dow Jones U.S. Dividend 100 Index, this index requires companies to have increased their dividend in each of the last 10 years. It then excludes the top 25% based on yield.

The result is a fund that’s closer to a blend fund than value. It valuation metrics are higher (it’s P/E ratio is about 25) and its dividend yield is lower. In addition, it has underperformed SCHD by about 1% over the past 10 years. Of course, who will win the next 10 years is anybody’s guess.

Still, it’s a sold choice for those who want a dividend focused ETF that slightly tilts toward growth.

Tracking Index: S&P U.S. Dividend Growers Index
TTM Yield: 1.48%
Dividend History: 10 consecutive years of dividend growth
Expense Ratio: 0.060%
AUM: $61.3 billion

3. Vanguard High Dividend Yield ETF (VYM)

The Vanguard High Dividend Yield ETF (VYM) tracks the FTSE High Dividend Yield Index. Good luck finding details on this index. The best I could find comes from Morningstar:

The fund tracks the FTSE High Dividend Yield Index, which captures the highest-yielding half of the universe of dividend-paying stocks in the large- to mid-cap U.S. equity market. The index starts with the FTSE USA Index and ranks its constituents by their projected 12-month yield. It then adds stocks by descending rank until 50% market-cap coverage of the universe of dividend payers is reached. As it aims for 50% market-cap coverage of this cohort, the fund tends to sweep in 400 to 450 stocks. Companies that have not paid dividends in the past 12 months or are not expected to pay one in the next 12 months are not eligible. REITs are also left out.

It’s noteworthy that the index doesn’t apply qualitative factors to its stock selection. Companies in the top 50% based on yield make the cut.

While the fund has trailed others on this list over the past decade, its portfolio could do well as we rotate from growth to value.

Tracking Index: FTSE High Dividend Yield Index
TTM Yield: 2.72%
Dividend History: 12 months
Expense Ratio: 0.060%
AUM: $38.0 billion

4. iShares Core Dividend Growth ETF

iShares Core Dividend Growth ETF (DGRO) tracks the Morningstar U.S. Dividend Growth Index. The index screens for companies that–

• pay qualified dividends
• have a minimum of five years of uninterrupted annual dividend growth.
• have a significant margin to continue growing dividends.

It excludes the top 10% of qualifying companies.

Tracking Index: Morningstar US Dividend Growth Index
TTM Yield: 2.00%
Dividend History: 5 years of uninterrupted dividend growth
Expense Ratio: 0.080%
AUM: $20.1 billion

5. SPDR S&P Dividend ETF

SPDR S&P Dividend ETF (SDY) tracks the S&P High Yield Dividend Aristocrats Index. While the Dividend Aristicrats include companies that have increased their dividends for the last 25 years, this index limits the screen to 20 years. With this adjustment, it adds about 50 companies to its portfolio.

SDY has been the worst performing ETF in our list over the past 10 years. Its dividend has also been inconsistent. It dropped significantly in 2016 and again in 2018. Keep in mind that companies get cut from the index if their dividend payments can’t keep up, while new companies join who meet the criteria. One does wonder, however, if the fund is poised for a turn around as interest rates rise.

Time will tell.

Tracking Index: S&P High Yield Dividend Aristocrats Index
TTM Yield: 2.60%
Dividend History: 20 consecutive year history of increasing dividends
Expense Ratio: 0.35%
AUM: $19.0 billion

3 Dividend ETFs to Avoid

Just because an ETF pays a high dividend doesn’t mean it’s a good investment. In fact, a yield significantly above the market’s average should serve as a warning to stay away. Here are three dividend ETFs I wouldn’t recommend.

1. SuperDividend ETF (SDIV)

The SuperDividend ETF (SDIV) invests in the 100 companies that pay the highest dividend yield. The result is a portfolio consisting of 30% U.S. companies and 70% international companies. While its current yield is above 7%, its annual returns over the past decade barely exceed 3%.

Beyond performance, the fund has a turnover ratio of more than 124% according to Stock Rover. This increases costs. And its standard deviation is near 30 according to Morningstar.

In short, to sacrifices total return for yield, has high turnover and is volatile, resulting in a very poor investment.

Tracking Index: Solactive Global SuperDividend Index
TTM Yield: 7.19%
Dividend History: Top 100 global dividend yield companies
Excluded: Companies excluded based on certain qualitative screens
Expense Ratio: 0.590%
AUM: $948.9 million

2. SuperDividend U.S. ETF

The SuperDividend® U.S. ETF (DIV) is the U.S. only version of the above fund. While its yield is lower, it still comes in above 5.5%. And like SDIV, its total returns were just about 3% over the past decade. Not only does the fund suffer from poor returns, its volatility is significantly higher than an S&P 500 fund.

As with SDIV, DIV has a turnover percentage of near 100% and a standard deviation of 28. In short, investors are paying 45 basis points for an underperforming fund that comes with more risk.

Tracking Index:  Indxx SuperDividend U.S. Low Volatility Index
TTM Yield: 5.61%
Dividend History: 12 month
Excluded: Dividend yields below 1% or above 20%
Expense Ratio: 0.450%
AUM: $655.8 million

3. Invesco High Yield Equity Dividend Achiever ETF

The Invesco High Yield Equity Dividend Achiever ETF (PEY) tracks the NASDAQ US Dividend Achievers 50 Index. The index in turn is comprised of the top 50 securities by dividend yield from the NASDAQ US Broad Dividend Achievers Index. The result is a focused fund that has significantly underperformed the S&P 500 while exposing investors to greater risk.

Tracking Index: NASDAQ US Dividend Achievers 50 Index
TTM Yield: 3.77%
Dividend History:
Expense Ratio: 0.520%
AUM: $936.7 million

Final Thoughts

Dividend investing can be a part of a reasonable investment plan. Dividend ETFs give investors exposure to value funds. Taken to extremes, however, a dividend focused investment strategy can result in lower total returns. As a result, care must be taken not to reach for yield, even in retirement.

Fidelity launched its ZERO index funds in 2018 to much fanfare. As their names suggest, these funds carry no expense ratios, a first in the industry.

As great as a “free” mutual fund may sound, however, many wonder whether there is a catch. Recently a subscribe to my YouTube channel asked the following questions:

Could you please share your thoughts on Fidelity ZERO funds vs their fee based funds?Fidelity ZERO International Index Fund (FZILX)Fidelity ZERO Total Market Index Fund (FZROX)Fidelity ZERO Large Cap Index Fund (FNILX)Fidelity ZERO Extended Market Index Fund (FZIPX)

Is FNILX + FZIPX = FZROX ?

ZERO funds have no fees, but other than cost, do you see any reason why one should invest in fee based instead of zero funds?

If you could please create video and share your thoughts, that would be very helpful.

Let’s dive into the details to get a better understanding of the Fidelity ZERO funds.

4 Fidelity Zero Funds

The ZERO funds consist of four index funds. These funds charge no fees in the form of an Expense Ratio, although they do pass on transaction costs to investors. There are also no minimum investment requirements.

The catch, if you want to call it that, is that the funds track proprietary indexes Fidelity created. That means, for example, that the Fidelity ZERO Large Cap index fund does NOT track the S&P 500, as one might expect.

Here are the details on each fund’s tracking index. (Note that Fidelity does not offer a ZERO fund for bonds.)

Fidelity ZERO Large Cap Index Fund (FNILX)

The Fidelity ZERO Large Cap Index Fund tracks the Fidelity U.S. Large Cap Index. The index is a float-adjusted market capitalization-weighted index. That simply means it tracks companies based on the number and value of shares outstanding in the market. Its focus is on the U.S. large capitalization equity market.

The index tracks the top 500 companies. It can, however, have fewer companies based on liquidity and investing screens that Fidelity uses. For example, the index (and the other two U.S. indexes discussed below) exclude companies with capitalizations under $75 million or with limited trading volume.

It can also have more than 500 stocks if some companies have multiple share classes. Fidelity rebalances the index annually on the third Friday in February (so mark your calendars!).

The index is similar to the S&P 500 index, but there are some differences, as we’ll see below.

Fidelity ZERO Extended Market Index Fund (FZIPX)

The Fidelity ZERO Extended Market Index Fund (FZIPX) tracks the Fidelity U.S. Extended Investable Market Index. Its designed to track U.S. mid- and small-cap stocks. It is a subset of the Fidelity U.S. Total Investable Market Index (see below), excluding the 500 largest companies.

Perhaps the closest comparison of this index is the the Dow Jones U.S. Completion Total Stock Market Index. The primary difference is that the Fidelity index is limited to 2,500 companies, whereas the Dow Jones index has just under 3,500 companies.

Fidelity ZERO Total Market Index Fund (FZROX)

The Fidelity ZERO Total Market Index Fund (FZROX) tracks the Fidelity U.S. Total Investable Market Index. This index is effectively a combination of the Large Cap and Extended Market indexes described above. As such, it is limited to 3,000 companies.

Its closest comparison is the Dow Jones U.S. Total Stock Market Index. It’s not an exact match, however, as the Down Jones index tracks nearly 4,000 companies.

Fidelity ZERO International Index Fund (FZILX)

Finally, the Fidelity ZERO International Index Fund (FZILX) tracks the Fidelity Global ex. U.S. Index. Fidelity designed this index to track mid- and large-cap companies headquartered outside the U.S. The index is created by selecting the top 90% of stocks as measured by market cap in each country.

This index is similar to the MSCI ACWI Ex USA Index. This index, however, holds about 4,700 companies, while the free version holds about 2,300 companies.

How Fidelity ZERO Funds Compare

While free funds offer an initial appeal, one wonders if investors are getting what they paid for. Are the Fidelity indexes used by the ZERO funds generating the same or better returns as the more widely used indexes? This is particularly important given that other Fidelity index funds, while they charge a fee, are still very close to $0 in cost (generally 6 basis points or less).

To get a better understanding, I compared each of Fidelity’s ZERO funds with a close counterpart offered by Fidelity.

FNILX vs FXAIX

Fidelity’s Large Cap ZERO fund is arguably the closest to its most comparable index, the S&P 500. A comparison of the fund to Fidelity’s S&P 500 index fund (FXAIX) in Morningstar shows very similar style boxes and the same top 10 holdings. The notable difference is in the percentage held of each of the top 10 companies (the ZERO fund is on the left in each snapshot).

Performance data on the ZERO funds is limited as the funds were launched in 2018. Nevertheless, since then the ZERO Large Cap fund has outperformed Fidelity’s S&P 500 index fund by substantially more than its 1.5 basis point fee:

Whether the ZERO fund will continue to outperform the S&P 500 index only time can tell. As you’ll see below, however, the other ZERO funds haven’t performed as well.

https://fundresearch.fidelity.com/mutual-funds/summary/315911750 (FXAIX)

FZIPX vs FSMAX

Fidelity’s Extended Market Index fund (FSMAX) tracks the Dow Jones U.S. Completion Total Stock Market index. Think of it as everything except the companies in the S&P 500. As such, it covers about 1,000 more companies than Fidelity’s proprietary completion index used for the ZERO extended fund. Its cost is just 3.5 basis points.

In the short time FZIPX has been available, it has significantly underperformed FSMAX even with the same volatility. Here are the comparisons:

FZROX vs FSKAX

Fidelity’s Total Market Index fund (FSKAX) is the closest comparable to its ZERO Total Market fund. FSKAX charges just 1.5 basis points and gives investors exposure to over 3,700 stocks. The ZERO fund, in contrast, holds about 2,600 equity holdings.

While returns thus far have been nearly identical, FSKAX has managed to edge out the ZERO fund by 2 basis points. The comparable performance is likely driven by the similar returns amongst the larges U.S. companies in these cap-weighted funds.

https://fundresearch.fidelity.com/mutual-funds/summary/315911693 (FSKAX)

FZILX vs FTIHX

Fidelity’s Total International Index (FTIHX) charges 6 basis points and tracks the MSCI ACWI ex USA Investable Market index. The style box for this and the ZERO International Index are nearly identical. The free fund, however, holds just under 2,400 stocks while FTIHX holds over 4,700 stocks. And FTIHX has edged out the ZERO fund in performance thus far.

Final Thoughts

The cost of most index funds have fallen dramatically over the last few decades. Today one can invest in an index fund for 10 basis points or less. In many cases, a fund costs less than 5 basis points. For that reason, Fidelity ZERO funds seem more like a marketing strategy than a product that meets investors’ needs.

Certainly free beats even a very small cost. The problem is that fidelity achieves a 0% Expense Ratio by tracking its own proprietary indexes. I’m not sure that’s worth saving a few basis points each year. And thus far, with perhaps the exception of the Large Cap ZERO fund, these funds have trailed their Fidelity counterparts by more that the cost savings.

That said, I would have no reservations investing in one of these funds in a 401k if it were my best option.

Resources

• https://www.fidelity.com/mutual-funds/investing-ideas/index-funds
• https://www.fidelity.com/bin-public/060_www_fidelity_com/documents/mutual-funds/Fidelity_mkt_cap_weighted_methodology.pdf

I first met Paul Merriman back in 2017. He was kind enough to come on my podcast to talk about what he calls the Ultimate Buy and Hold Portfolio. We’ve kept in touch over the years, and in fact we were just talking about a month ago. In this article we’ll dig into the details of his investing strategy.

Who is Paul Merriman?

Paul founded an investment advisory firm back in 1983. He retired in 2012, and in 2013 he started the Merriman Financial Education Foundation where he helps educate investors. He’s also published several books, including his most recent one, We’re Talking Millions!: 12 Simple Ways To Supercharge Your Retirement.

Over the years he’s developed what he calls the Ultimate Buy and Hold Portfolio. As you’ll see, it consists of 10 stock asset classes, each implemented with a low cost index mutual fund or ETF.

The Ultimate Buy and Hold Portfolio

Stocks

There are several versions of Paul’s Ultimate Buy and Hold Portfolio. We’ll spend most of our time looking at the version that has become famous over the years. It consists of the following 10 stock asset classes:

• S&P 500
• U.S. Large Cap Value (LCV)
• U.S. Small Cap Blend (SCB)
• U.S. Small Cap Value (SCV)
• Real Estate Investment Trust (REIT)
• International Large Cap Blend (LCB)
• International LCV
• International SCB
• International SCV
• Emerging Markets

Paul allocates the equity portion of a portfolio equally across these asset classes. For example, a portfolio of 100% stocks would see 10% allocated to each asset class. An 80/20 portfolio would have 8% allocated to each class, with 20% going to one or more bond funds (we’ll look at examples in a moment, but you can check out Paul’s portfolio implemented as a 80/20 portfolio on M1 Finance.)

Bonds

Merriman recommends three types of bonds for the fixed income portion of his strategy:

• Intermediate term Treasury bonds (50% of total bonds)
• Short term Treasury bonds and bills (30%)
• Short term TIPS (20%)

I agree with much of what he suggests. He’s avoided high-risk bonds such as those issued from emerging market governments or troubled corporations. He’s also kept to a shorter yield curve and added some exposure to inflation protected securities.

If there’s any aspect I might adjust it’s to add more TIPS. If you believe inflation will be higher in the future than the market is predicting, TIPS are a way to place that bet. In contrast, if you think inflation will be lower than expected, Treasury bonds are the answer.

For those like me who have absolutely no idea, you split your bond portfolio equally between the two. That’s exactly what the David Swensen Portfolio does. The only caveat today is that TIPS start with a negative yield, and if you’re like me, that’s a hard pill to swallow. Nevertheless, that’s how I’ve implemented the Ultimate Buy and Hold strategy in M1 Finance.

How the Ultimate Buy and Hold Portfolio is Different

There are several aspects to note about Merriman’s investing strategy:

International Exposure: The portfolio allocates a full 50% of equities to international funds. This is unique among the portfolio’s I’ve evaluated. Most are less than 50%. The Warren Buffett Portfolio doesn’t allocate anything directly to international stocks. And Vanguard’s founder, Jack Bogle, saw no need to own international stocks.

I personally think international exposure is important. My portfolio allocates about 30% to global funds.

Small Cap Exposure: The Ultimate Buy & Hold portfolio allocates 20% to small cap stocks. It does so because history tells us that small cap companies out perform large cap companies over the long term. Over the past 50 years, small cap has outperformed large cap by more than 1%. A $10,000 investment beginning in 1972 would grow to more than $2.7 million if invested in small companies, compared to $1.5 million in large companies.

Value Exposure: Finally, Merriman’s strategy favors value investments over growth. Again, history tells the story. Although growth stocks have outperformed value recently, over the last 100 years, value has performed better in both large and small companies.

Historical Performance of the Ultimate Buy and Hold Strategy

The big question is how Merriman’s Ultimate Buy and Hold portfolio has performed. As you can see in the chart below (click the image to enlarge it), the portfolio has trounced the S&P 500 over the last 50 years.

The portfolio has returned 12.4% annually compared to 10.7% for the S&P 500. Note, however, that it comes with more risk. The standard deviation of Merriman’s portfolio, when rebalanced annually, weighs in at 18.5%, compared to 16.9% for the S&P 500. In other words, if you can handle the volatility, Merriman’s portfolio may be a sound option. Note too that by rebalancing monthly, you decrease both the returns and volatility.

Before we leave the performance of this investing strategy, it’s worth looking at how well it’s done over the last decade. As you can see, the portfolio has lagged the S&P 500 since 2010:

Why? Over the last decade large companies have outperformed small companies, growth companies have outperformed value companies, and U.S. companies have outperformed international companies. In other words, in just about every way that the Buy and Hold portfolio overweights has seen underperformance.

Much of this is the result of a low inflation, and easy money policy of the Fed and federal government. Massive borrowing and spending has sent asset prices soaring, which favors larger growth companies.

I don’t believe this undermines Merriman’s portfolio. The U.S. can’t borrow to infinity. But it does underscore that any investment strategy can lag the market for extended periods of time.

Building the UB&H Strategy

There are a number of ways to construct the Ultimate Buy & Hold Strategy. I’ve built one approach in M1 Finance using low cost index ETFs:

Keep a few things in mind. First, the above portfolio is 80% stocks and 20% bonds. One can easily change this to whatever stock/bond allocation is best to meet their investment goals.

Second, some of the chosen ETFs cover more than one asset class. For example, Vanguard’s small-cap ETF (ticker: VB) includes mid-cap companies. I think this is a perfectly reasonable approach to the UB&H strategy, but one could easily substitute a micro-cap ETF (e.g, iShares Micro-Cap ETF IWC).

Here’s what the asset allocation looks like in Personal Capital:

Finally, M1 Finance is ideal for this portfolio as it makes rebalancing easy. With M1, you can rebalance a portfolio with the click of a button.

The Simplified Ultimate Buy and Hold Portfolio Alternative

Paul Merriman and his team have released simplified versions of the UB&H portfolio. These are ideal for those who don’t want to juggle 10 stock asset classes! He has both a 4-fund and a 2-fund solution.

4-Fund Ultimate Buy and Hold Portfolio

The Merriman 4-Fund Portfolio (see it here at M1 Finance) consists of the following four asset classes:

• LCB (S&P 500)
• LCV
• SCB
• SCV

This portfolio’s performance is similar to the 10-fund portfolio. It has averaged 13.8% over rolling 15-year periods since 1928. The S&P 500 has averaged just 11.0%.

2-Fund Ultimate Buy and Hold Portfolio

The 2-fund solution has performed even better. Its average performance over rolling 15-year periods is an amazing 14.5%. Here, however, some cautionary words.

The 2-fund portfolio bets everything on value investing. The two asset classes are SCV and LCV. In the short to medium term, this portfolio could significantly underperform the market, such as what the 3-fund portfolio seeks to replicate.

Final Thoughts

The 10-fund Ultimate Buy & Hold portfolio is an excellent way to potentially outperform the market without sacrificing diversification. It does, however, represent a more volatile approach to investing. Therefore, it’s not for everyone. At the same time, one can modify the portfolio to better suit individual approaches to investing.

My Research for this Article

• Ultimate Buy and Hold Portfolio (via M1 Finance)
• 4-Fund Buy and Hold Portfolio (via M1 Finance)
• About Paul Merriman
• Jack Bogle on International Investing
• The Ultimate Buy and Hold Strategy: 2021 Update
• Worldwide Equity Portfolio Tables 50% US/50% Int’l
• Simplified Ultimate Buy and Hold Portfolio
• 4-Fund Combo Latest Recommendations

The Ray Dalio All Weather Portfolio is designed to perform well in any economic cycle. Using risk parity to match asset classes to economic risk, the portfolio promises to perform well in any market with less volatility than traditional asset allocation models. In this article, we’ll examine the portfolio to see if it should be part of our investment strategy.

Resources and Tools Mentioned in this Article:

• Ray Dalio All Weather Portfolio (implemented via M1 Finance)
• 2x Ray Dalio All Weather Portfolio (implemented via M1 Finance)
• Money Master the Game: 7 Simple Steps to Financial Freedom by Tony Robbins (2016)
• Why in the World Would You Own Bonds When . . . by Ray Dalio (2021)
• Principles: Life and Work by Ray Dalio (2017)
• The Bridgewater All Weather Fund Story
• The Definitive Guide to the All Weather Portfolio, by Nick Maggiulli
• Portfolio Visualizer
• Personal Capital

Who is Ray Dalio?

Ray Dalio is a billionaire investor and hedge fund manager. Dalio founded Bridgewater Associates in 1975 and built it into the largest hedge fund in the world with $140 billion in assets under management. He is the author of Principles: Life and Work (2017). 

Dalio is a student of economic cycles. He recently produced a video describing how economic cycles work:

It’s his view on economic cycles that informs his All Weather Portfolio.

The Ray Dalio All Weather Portfolio

The Bridgewater Associates All Weather Fund

The All Weather portfolio dates back to 1996. It was the product of analysis by Bridgewater’s Bob Prince and Ray Dalio, among others. What they found is the economic cycles revolve around two things: Inflation/deflation and growth/contraction.

Source: https://www.bridgewater.com/research-and-insights/the-all-weather-story

As growth and inflation rise and fall, different asset classes either rise and fall. The goal of the All Weather portfolio was to gain exposure in roughly equal percentages of the various asset classes that perform well in each quadrant. At Bridgewater, the result was the following:

• EM Credit: Emerging Market Debt
• IL Bonds: Inflation-linked bonds (Tips, I Bonds)
• Nominal Bonds: Bonds not linked to inflation (e.g., Treasury bonds)

Unlike a traditional asset allocation, the All Weather portfolio allocates just 25% or thereabouts to equities. The rest of the portfolio goes to various bonds and commodities, including gold. In this regard, in stands in sharp contrast to the 3-Fund Portfolio and the Warren Buffett Portfolio.

The above portfolio at Bridewater was available to corporate clients and pension funds. It was not available to the average investor, until recently.

The All Weather Portfolio

In 2016 Tony Robbins published Money Master the Game: 7 Simple Steps to Financial Freedom. For the book Robbins interviewed Dalio, who outlined the All Weather Portfolio in a way that average investors could mimic.

The portfolio consisted of the following asset classes:

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

According to Tony Robbins, here are the performance metrics for the portfolio from 1984 to 2013:

• 9.7% annual returns
• You would have made money 86% of the time
• Average loss of just 1.9%
• Worst loss was -3.9%
• Volatility of 7.6%

The returns are remarkable given a volatility (standard deviation) of just 7.6%. By way of comparison, the S&P 500 has a standard deviation of more than 15%.

One way to implement this portfolio is to use the following ETFs:

• VTI    30%
• VGLT 40%
• USCI  7.5%
• GLD   7.5%
• BIV     15%

I’ve created this portfolio in M1 Finance which you can check out here.

As noted earlier, this portfolio’s asset allocation is anything but traditional. Here’s a view of the allocation using Personal Capital’s Asset Allocation Tool:

Backtesting of this portfolio is limited due to the commodities ETF. Still, we can see that it performed reasonably well since 2011 as compared to the Bogleheads 3-Fund Portfolio (80/20 allocation):

Note that it was neck-in-neck with the 3-fund portfolio until the recent post-Covid shock bull market. What’s noteworthy is that the Dalio portfolio’s standard deviation is just 6.23%, compared to 11.05% for the 3-fund portfolio. This in turn explains in part a Sharpe Ratio and Sortino Ratio much higher than the 3-fund portfolio.

In other words, the Ray Dalio portfolio performed better than the 3-fund portfolio on a risk-adjusted basis. At the same time, one can’t ignore that the 3-fund portfolio outperformed.

Long-term Bond Exposure

It’s hard to ignore the portfolio’s exposure to long bonds (and even intermediate term bonds) given current interest rates. If you believe that rates will rise, parking 40% of a portfolio in long-term bonds could be a recipe for disaster. Even Ray Dalio today questions why anybody would own bonds.

In his recent article, Why in the World Would You Own Bonds When…, Mr. Dalio described the economics of investing in bonds as stupid:

The economics of investing in bonds (and most financial assets) has become stupid.

He went on to explain why he believes bonds are in a bubble:

…If bond prices fall significantly that will produce significant losses for holders of them, which could encourage more selling. Bonds have been in a 40-year bull market that has rewarded those who were long and penalized those who were short, so the bull market has produced a large number of comfortable longs who haven’t gotten seriously stung by a price decline. That is one of the markers of a bubble.

Beyond the end of the 40-year bull run in bonds, Dalio goes so far as to say shorting bonds is a “relatively low-risk bet.”

If Dalio is right, and I believe he is, it calls into question the sustainability of the All Weather portfolio. Keep in mind that he recommended it to Tony Robbins in 2016. A lot has changed in the last five years.

2x Leveraged Ray Dalio Portfolio

It is worth asking whether it makes sense to used leveraged ETFs with the All Weather Portfolio. While I’m generally opposed to such measures, it’s common in risk parity portfolios to see leverage deployed to offset the low risk (i.e., low volatility) that these portfolios generate. The idea is to bring the volatility of the portfolio back in line with traditional asset allocation models, while enjoying slightly higher returns.

Creating the portfolio is easy in M1 Finance using ProShares ETFs. Here’s what it looks like:

Examining this portfolio in Portfolio Visualizer led to some interesting results. What follows is a comparison of this portfolio, the standard All Weather Portfolio, and a 3-fund portfolio using an 80/20 allocation:

It’s not surprising that the leveraged portfolio (Portfolio #1) outperformed the unlevered portfolio (Portfolio #2). What is more interesting is that it trounced the 3-fund portfolio (Portfolio #3) on both a total return basis and a risk adjusted basis (see both the Sharpe and Sortino ratios).

Pros & Cons of the Ray Dalio All Weather Portfolio

In the final analysis, the Rad Dalio All Weather Portfolio has several pros and cons:

Pros

• Easy to implement with ETFs
• Volatility lower than a “traditional” portfolio
• Sharpe and Sortino ratios higher than a “traditional” portfolio

Cons

• May underperform a 3-fund portfolio unless leverage is used
• 50%+ allocation to intermediate and long-term bonds not ideal in current interest rate environment
• Exposure to commodities and gold can underperform for long periods of time.