Portfolio Allocation Backtesting: 60/40 vs All-Weather vs Risk Parity

# Portfolio Allocation Backtesting: 60/40 vs All-Weather vs Risk Parity

Portfolio allocation is perhaps the most impactful investment decision you will make. Academic research consistently shows that asset allocation explains over 90% of return variability over time. We backtested three popular allocation approaches to determine which best serves long-term investors across different market environments.

The Contenders

Our three strategies are: the classic 60/40 portfolio (60% US stocks, 40% US bonds), Ray Dalio's All-Weather portfolio (30% stocks, 40% long-term bonds, 15% intermediate bonds, 7.5% commodities, 7.5% gold), and a Risk Parity approach that allocates inversely to volatility so each asset contributes equal risk to the portfolio. All are rebalanced quarterly.

Implementation Details

For backtesting, we used: SPY for US stocks, TLT for long-term bonds, IEF for intermediate bonds, DBC for commodities, and GLD for gold. For the extended backtest (1972-2024), we used corresponding index data from CRSP and Bloomberg. Risk Parity weights were calculated using trailing 60-day volatility of each asset. All returns include dividends and assume 0.05% rebalancing cost per transaction.

Overall Performance (1972-2024)

The 60/40 portfolio returned 9.8% annualized with a 29% maximum drawdown and 0.58 Sharpe ratio. All-Weather returned 8.2% annualized with a 14% maximum drawdown and 0.63 Sharpe ratio. Risk Parity returned 8.9% annualized with a 18% maximum drawdown and 0.71 Sharpe ratio. Risk Parity produced the best risk-adjusted returns, while 60/40 had the highest absolute returns.

Performance During Market Crises

During the 2008 financial crisis, 60/40 lost 32%, All-Weather lost 12%, and Risk Parity lost 16%. During the 2022 rate hiking cycle (when both stocks and bonds fell), 60/40 lost 17%, All-Weather lost 22%, and Risk Parity lost 19%. This reveals a critical vulnerability: All-Weather's heavy bond allocation becomes a liability during rising rate environments. No single allocation strategy dominates across all crisis types.

The 2022 Problem: Death of Diversification?

The 2022 experience, where stocks and bonds fell together for the first time in decades, challenged all three approaches. This positive stock-bond correlation environment is actually the historical norm rather than the exception. From 1972-1997, stock-bond correlation was frequently positive. The negative correlation regime (2000-2021) was historically unusual and may not persist. This has profound implications for bond-heavy allocations like All-Weather.

Decade-by-Decade Analysis

Performance varied significantly by decade. In the 1970s (high inflation), All-Weather outperformed due to commodity and gold exposure. In the 1980s and 1990s (falling rates, stock boom), 60/40 dominated due to its higher equity allocation. In the 2000s (two bear markets), All-Weather and Risk Parity outperformed. In the 2010s (low volatility bull market), 60/40 won again. The lesson is clear: each approach has its era of dominance.

Adding Alternative Assets

We tested enhancements to each strategy by incorporating REITs, international stocks, and TIPS. Adding 10% REITs and 10% international stocks to the 60/40 portfolio improved the Sharpe ratio from 0.58 to 0.64. Adding TIPS to All-Weather as an inflation hedge improved its performance during 2022 by 4%. These modifications show that broader diversification within each framework improves robustness across regimes.

Rebalancing Frequency Impact

We tested monthly, quarterly, and annual rebalancing for each strategy. Quarterly rebalancing provided the best balance between maintaining target allocations and minimizing transaction costs and taxes. Monthly rebalancing added marginal improvement (0.1% annualized) that was consumed by extra costs. Annual rebalancing allowed drift to accumulate excessively, particularly in Risk Parity where volatility changes can alter optimal weights quickly.

The Role of Leverage in Risk Parity

True institutional Risk Parity (as practiced by Bridgewater) uses leverage to bring the low-volatility assets (bonds) up to equalize their risk contribution with stocks. Without leverage, Risk Parity portfolios tend to have conservative returns. With 1.5x leverage, our Risk Parity approach returned 12.3% annualized but with a 27% maximum drawdown. Leverage amplifies both returns and risks, and leverage costs (margin rates) erode the benefit in practice.

What About Timing?

We tested adding a simple timing overlay to each allocation: reduce equity exposure by half when the S&P 500 is below its 200-day moving average. This timing overlay improved the 60/40 portfolio dramatically (Sharpe from 0.58 to 0.76) by reducing bear market exposure. It added less value to All-Weather and Risk Parity because those portfolios already had lower equity exposure. The simplest improvements often come from basic trend following on the equity sleeve.

Our Recommendation

For most long-term investors, a modified 60/40 portfolio with broader diversification (adding international, REITs, and TIPS) and a simple trend-following overlay on the equity allocation provides the best combination of simplicity, performance, and robustness. Risk Parity offers superior risk-adjusted returns but requires more complex implementation and potentially leverage. All-Weather provides the smoothest ride but underperforms during rising rate environments and high-equity bull markets.

Conclusion

No portfolio allocation strategy is optimal in all environments. The best choice depends on your time horizon, risk tolerance, and which future economic regime materializes. Backtesting across 50+ years reveals that diversification across asset classes and regime-adaptive elements (like trend following overlays) matter more than the specific static allocation percentages. Focus on building a portfolio that survives every environment rather than one that is optimal in any single environment.