For the past 25 years, the asset allocation pie chart has been the most prominent and widely used tool in financial planning. Type in your age, some basic income and risk tolerance information and out comes a recommended formula for how much money you should have in stocks, bonds and cash.
In this installment of Investing 101, we take this methodology to the next level, with a look at Risk Parity Investing. Although it has existed for over 50 years, practitioners like Lee Partridge, the CIO of Salient Partners, says by attempting to smooth out returns, it is gaining converts by the day.
"At its core, risk parity does two things; it targets a specific level of risk, then it divides that risk equally across four component parts of the portfolio to achieve true diversification," Partridge says in the attached video. Compared to a plain vanilla stocks and bonds portfolio where he says a 60% allocation of stocks drives about 95% of the returns and volatility, a risk parity investor's holdings will look totally different.
"In order to achieve 25% risk from equities, you only need about 20% of your portfolio in stocks," Partridge says, "far less than what individual investors are accustomed to."Read More »from Risk Parity Investing: A New Allocation Model Is Here