Risk Parity

Risk Parity is an asset allocation framework that distributes capital based on the risk (volatility) contribution of each asset class, rather than allocating fixed dollar percentages.

In a traditional 60/40 stock/bond portfolio, stocks contribute roughly 90% of the total portfolio risk because stocks are about three times more volatile than bonds. If stocks crash, the portfolio crashes, regardless of the 40% bond buffer. Risk parity solves this by equalizing the risk contribution.

To achieve risk parity, a portfolio must allocate more capital to low-volatility assets (like bonds) and less capital to high-volatility assets (like stocks or commodities). The public adaptation of Ray Dalio's All Weather Portfolio uses this concept by allocating 55% to bonds, 30% to stocks, and 15% split between gold and commodities.

By balancing risk exposures across growth, deflation, and inflation hedges, risk parity portfolios aim to deliver steady returns with smaller drawdowns across all economic regimes. However, because they are bond-heavy, their performance is sensitive to rising interest rate environments.