Balanced Asset Allocation: How to Profit in Any Economic Climate

Chapter 9How to Build a Balanced PortfolioConceptual Framework

This chapter is about how to achieve a balanced portfolio. For reasons I will explain here, the best portfolio is the most balanced portfolio. What I am going to show you was discovered by Ray Dalio and his team at Bridgewater.

It is easy to make money when economic growth is rising and the stock market is soaring. You really don't need to read a book to enjoy success during those environments. However, the key to successful long-term investing is whether you are able to survive economic troughs. How does your portfolio perform during the difficult times? How vulnerable is it to adverse economic climates, and are the potential dips in asset value so significant as to result in catastrophic losses? The framework behind construction of a balanced portfolio is to account for all contingencies so that you have a good chance of surviving the inevitable bad times and participating in strong economic environments.

More specifically, the idea behind a balanced portfolio is to achieve steady returns over the long run and to minimize the risk of major drawdowns and prolonged periods of underperformance. In order to achieve these objectives, you need to first identify where returns come from and why they are volatile. Earlier in the book I identified the key drivers of asset class returns. I established that returns fluctuate due to unexpected changes that inevitably occur in the following three areas:

1. Economic environment ...