Traditional portfolios, like the 60/40 mix of stocks and bonds, allocate capital, not risk.
This creates an imbalance: the equity portion drives most of the volatility, while bonds contribute relatively little.

Risk Parity — the philosophy behind Bridgewater Associates’ famous All Weather Portfolio — takes the opposite approach.
It allocates assets based on risk contribution, not dollar amount, creating a portfolio designed to perform across all economic environments.

This article explains the logic behind risk parity, how it works, why it’s different from traditional allocation, and how the All Weather Portfolio is constructed.

1. What Is Risk Parity?

Risk Parity is an investment framework that distributes risk evenly across asset classes instead of concentrating it in equities.

In a traditional portfolio:

• Stocks contribute ~90% of the risk
• Bonds contribute ~10%
• Commodities contribute almost none

Risk Parity fixes this imbalance by:

• lowering exposure to volatile assets (like equities)
• increasing exposure to stable assets (like bonds)
• using leverage to scale low-risk assets
• adding asset classes to handle diverse environments

The goal: a portfolio where each asset class contributes an equal share of total risk.

2. Why Traditional Portfolios Are Unbalanced

A 60/40 portfolio sounds diversified, but it isn’t.

Capital allocation:

• 60% stocks
• 40% bonds

Risk allocation:

• 85–95% of total risk comes from stocks

Because stocks are far more volatile than bonds, they dominate performance.
When stocks struggle, the whole portfolio struggles.

Risk Parity solves this by ensuring no single asset class dominates portfolio volatility.

3. The Core Idea: Balance Across Economic Regimes

The economy cycles through four major regimes:

No single asset performs well in all environments.

For example:

• Stocks thrive in rising growth
• Bonds thrive in falling growth
• Commodities thrive in rising inflation
• Cash + bonds help in deflationary periods

The All Weather Portfolio is engineered to handle all four.

4. How Risk Parity Works in Practice

Here’s the process:

Step 1: Identify asset classes with different sensitivities

The All Weather model uses:

• Equities
• Bonds (long-term and intermediate)
• Inflation-linked bonds
• Commodities
• Gold

Each reacts differently to growth and inflation.

Step 2: Estimate volatility

Higher-volatility assets get smaller weight; low-volatility assets get larger weight.

Example:

• Stocks: high volatility → low weight
• Bonds: low volatility → high weight

Step 3: Use leverage to scale low-risk assets

Since bonds and commodities have lower volatility, leverage is used to give them equal risk weight.

Step 4: Achieve equal risk contribution

Ideally something like:

• Equities: 25% of total portfolio risk
• Nominal bonds: 25%
• Inflation-linked bonds: 25%
• Commodities: 25%

These percentages are risk, not dollars.

5. The All Weather Portfolio: A Simplified Breakdown

A simplified All Weather allocation might look like:

• 30% Stocks
• 40% Long-term bonds
• 15% Intermediate bonds
• 7.5% Commodities
• 7.5% Gold

This is not equally weighted in capital terms — but it approximates equal risk weighting.

Why so many bonds?

Because:

• bonds have much lower volatility
• they must be overweighted to balance stock risk
• leverage may be added in institutional setups

Retail implementations skip or reduce leverage, but still benefit from the philosophy.

6. Why Risk Parity Works

1. True Diversification

The portfolio owns assets that behave differently across economic regimes.

2. Smoother Ride

Volatility is lower because risk is evenly distributed.

3. Strong Defense in Downturns

When stocks fall, other assets pick up the slack.

4. Discipline & Repeatability

The framework is systematic and not dependent on market timing.

5. Designed for All Conditions

Instead of predicting the future, the portfolio prepares for every possibility.

7. Risks and Criticisms of Risk Parity

Risk Parity is powerful, but it has weaknesses:

A. Reliance on Leverage

Institutional risk parity strategies use leverage — which adds:

• borrowing costs
• margin call risk
• liquidity considerations

B. Underperformance in Strong Bull Markets

When equities dominate returns, risk parity can lag traditional 60/40 portfolios.

C. Bond Dependence

Low yields or rising-rate environments can reduce bond effectiveness.

D. Complexity

It requires ongoing rebalancing and risk assessment.

E. Correlation Shifts

If asset correlations converge (e.g., stocks and bonds falling together), diversification benefits decline.

8. When Risk Parity Shines

Risk parity performs especially well when:

• markets are volatile
• inflation is uncertain
• growth cycles are unclear
• investors seek smoother return profiles
• long-term stability is prioritized over maximizing upside

It is ideal for institutions with long horizons and low tolerance for large drawdowns.

9. When to Avoid or Modify Risk Parity

It may not fit investors who:

• want maximum upside in bull markets
• dislike leverage
• cannot tolerate tracking error relative to equities
• want simple, low-maintenance portfolios

Modifications (like lower bond weights) can adapt risk parity to current markets.

Final Takeaway

Risk Parity and the All Weather Portfolio represent a shift from allocating by capital to allocating by risk.
By balancing asset classes across economic regimes, the strategy aims to deliver:

• smoother long-term returns
• fewer drawdowns
• better diversification
• resilience in unpredictable markets

It is not the highest-return strategy in every environment — but it is one of the most stable and thoughtful frameworks for long-term investing.