Master Investor Ray Dalio's Strategy Shows Up in This ETF -- And It Could Help You Invest More Confidently

It's only when markets are choppy that investors find out what their real risk tolerance is. It's easy to fill out a questionnaire and say you'd be able to withstand a correction or bear market, but it's another thing entirely to actually see 10%, 20%, or more of your portfolio wiped out -- often more quickly than you'd expect.

If you're finding that you're less tolerant of risk than you expected in the downturn over the past month, then the concept of an "all-weather portfolio" might appeal to you. One well-known investor has come up with a popular strategy for building such a portfolio, and exchange-traded fund investors now have access to it through the State Street Bridgewater All Weather ETF (NASDAQ: ALLW). There have been two articles discussing this ETF in the past couple of days for the Voyager Portfolio, but in this third and final article in the series, you'll learn straight from Bridgewater founder and investing guru Ray Dalio exactly what underpins the strategy the ETF follows.

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Dalio on all-weather investing

Just a week ago , Dalio set out the case for building an all-weather portfolio. By Dalio's definition, that entails:

• Having a well-diversified portfolio.
• Having that portfolio generate the best returns with the lowest risk.
• Implementing an investing strategy that doesn't require investors to time the market successfully.

Traditional financial planners have tended to gravitate toward balanced portfolios of bonds and stocks to achieve the best balance of returns and risk. One particularly popular strategy involves having 60% of your portfolio in stocks and 40% in bonds. Much of the time, stocks will outperform bonds, but having a sizable stock allocation will still dramatically outperform cash investments even with bonds holding back the portfolio's overall return. Meanwhile, when stocks are doing poorly, bonds will often perform well. That offsets losses and keeps the overall risk level of the portfolio lower.

Beating the 60/40 strategy

However, Dalio found that the quest for an all-weather strategy is a bit more complicated than that. Two key concepts augment an ideal all-weather portfolio.

First, going beyond traditional bonds and stocks can help investors manage risk more effectively. In particular, gold and other commodities often have their best performance during periods of inflationary pressures, and having some allocation to commodities can help make portfolios more efficient and diversified. In addition, although many advocates of the 60/40 strategy use only traditional fixed-income securities, the emergence of inflation-indexed bonds offers opportunities for portfolio outcomes that standard bonds can't match.

Second, putting together the best portfolio requires knowing how all these asset classes interact with one another during different market environments. Each asset class responds differently to changes in macroeconomic growth rates as well as to inflation. Adjusting allocations to reflect the different responses is crucial to manage risk optimally.

The State Street Bridgewater All Weather ETF implements this strategy consistently with Dalio's vision. There is a small element of market timing, though, as the fund subtly adjusts its exact asset allocation mix over time. For the most part, though, the simple principles Dalio set out show up clearly in the ETF's methodology.

Looking for the all-clear

Investors seeking an all-weather portfolio need to understand that it won't always be a top performer in every market. Following such a strategy requires long-term conviction along with a recognition that seeking a lower risk level will likely mean lower average returns than a simple stock-focused portfolio would generate.

That makes the State Street Bridgewater All Weather ETF an imperfect fit for the Voyager Portfolio. But if you're finding that investing in the stock market carries more risk than you're comfortable with, alternatives like the all-weather ETF could be a good alternative.

Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.