What is Risk Parity?
Risk parity allocates capital so that each asset class contributes equally to total portfolio risk. A traditional 60/40 portfolio derives roughly 90% of its risk from equities. Risk parity recognizes that stocks are about three times more volatile than bonds, so it holds three times more bonds than stocks, resulting in allocations like 25% stocks and 75% bonds. The risk is then truly diversified across asset classes.
The All Weather Approach
Ray Dalio's Bridgewater All Weather fund is the most famous risk parity implementation. It divides economic environments into four quadrants (rising/falling growth crossed with rising/falling inflation) and allocates equal risk to assets that perform well in each: equities for rising growth, long-term bonds for falling growth, commodities for rising inflation, and inflation-linked bonds for falling inflation.
Takeaways for Individual Investors
Pure risk parity requires leverage to boost bond returns to equity-like levels, which is impractical for most individuals. But the insight that a 60/40 portfolio is really a 90/10 risk portfolio is valuable. Simply knowing this helps you evaluate whether your portfolio's risk profile matches your actual tolerance. Increasing bond allocation or choosing lower-volatility equity strategies can reduce the hidden equity risk concentration.