By Jonathan Chevreau on February 2, 2023
Estimated reading time: 7 minutes

Are ETFs a good investment for an all-weather portfolio?

By Jonathan Chevreau on February 2, 2023
Estimated reading time: 7 minutes

Inflation and other factors are making investors rethink what a safe investment means, plus how to balance out an all-weather portfolio.

Playing on the words "all-weather" a man is walking outside in the snow, fully dressed and ready for the weather.

Photo by Mikhail Nilov from Pexels

For retirees and near retirees, it can sometimes seem like there’s no such thing as a “safe” investment—especially now. Even bonds and bond funds, typically considered the safest of investments—suffered losses in 2022, as central banks hiked interest rates. Meanwhile, stocks look determined to retreat from the all-time highs they reached in the year following the short-lived initial COVID bear market.

It’s true short-term bank savings accounts and guaranteed investment certificates (GICs) seem relatively safe from both stock meltdowns and precipitous rises in interest rates, but now there’s the added scourge of rising inflation. Even if you can earn 5% annually on a GIC, if inflation is running at 6%, you’re actually losing 1% a year.

Are ETFs a good investment for an all-weather portfolio?

It’s tempting to throw your hands up and retreat to those much-praised asset allocation exchange traded funds (ETFs). You can use these types of investments to simulate the classic pension mix of 60% stocks to 40% bonds through Vanguard Canada’s VBAL or similar ETFs from rivals, including iShares’ XBAL and BMO’s ZBAL. These vendors also offer alternative asset mixes catering to more aggressive and more conservative investors.

A nice feature of asset allocation ETFs is automatic rebalancing. If stocks go too high, they will at some point plough back some of the gains into the bond allocation, which indeed may be cheaper as rates rise. Conversely, if stocks plummet and the bonds rise in value, the asset allocation ETFs will snap up more stocks at cheaper prices.

Is the traditional 60/40 portfolio really well balanced?

These are all good reasons to make such funds the core of your portfolio. But are asset allocation ETFs suitable for any economic scenario? Any of the above fund products will own thousands of stocks and bonds from around the world, so they are certainly geographically diversified. However, from an asset class perspective, the focus on stocks and bonds means the ETFs are lacking many other possibly non-correlated asset classes, including commodities, gold and precious metals, real estate, cryptocurrencies and inflation-linked bonds, to name the major ones.

In his book, Balanced Asset Allocation, Alex Shahidi says you may think “your portfolio is well balanced, but it is not.” The conventional 60/40 stock/bond portfolio “is not only imbalanced, but it is exceedingly out of balance.” The problem is the conventional balanced portfolio is 99% correlated to the stock market, Shahidi argues.

At least one financial advisor consulted for this article agrees.

“What was once the staple of retirees, the 60/40 portfolio is no longer viable,” says Matthew Ardrey, wealth advisor with Toronto-based TriDelta Financial. “Bonds were the safe harbour of retired investors, providing income through interest payments and an offset to the volatility of stocks. In 2022, we are in a much different world than we were when I started in this industry over 20 years ago. Bonds now face two major risks: Interest rate and inflation.”

What’s needed, writes Shahidi, is a “new lens” to assess an asset class as “not as something that offers returns, but as something that offers different exposures to various economic climates.” In short: A broadly diversified all-weather portfolio with multiple uncorrelated (or only partly correlated) asset classes, which will work in inflation, deflation, rising growth (stock bull markets) or falling growth (stock bear markets).

Shahidi’s book takes The All-Weather portfolio, created by billionaire Ray Dalio, founder of Bridgewater Associates, as its starting point. It resembles the legendary Harry Browne’s Permanent Portfolio, which advocated holding just four asset classes in four equal 25% portions: stocks for prosperity, long-term bonds for deflation, gold for inflation and cash for recessions.

Dalio’s All-Weather portfolio goes further, though. You can find any number of variants of this portfolio by googling “all weather,” which will also yield various videos on YouTube.

In this version, the recommended stock mix is a surprisingly low 30% in stocks (mostly U.S. stocks); a whopping 55% in fixed income; 7.5% in commodities; and 7.5% in gold. Gold is played through the GLD ETF, commodities through the GSG ETF (some choose DBC), and U.S. stocks through the VTI ETF (variants include SPY or a global stock ETF). A 40% U.S. long-term bond weighting is through TLT and 15% in intermediate-term U.S. bonds through IEI.

Other all-weather versions, including the ones in Shahidi’s book, include in the bond holdings exposure to Treasury Inflation-Protected Securities (TIPS), an asset class that Dalio’s firm, Bridgewater, helped the U.S. government develop in the mid-1990s.

Ardrey agrees with having some allocations in commodities. He also says gold works OK as an inflation hedge, and “it seems crypto is being used for a similar purpose. I would not advocate to have crypto for a retiree though.” However, “55% in bonds is way too high in my opinion.” He adds that the returns Dalio shows “are historical, which is during the times where inflation was much lower and interest rates falling. Now conditions are opposite.”

So, Ardrey would add more to stocks and alternatives and reduce exposure to bonds.

The unique needs of Canadians with all-weather portfolios

Canadians will want more Canadian exposure than Dalio’s U.S.-oriented portfolio, especially in taxable portfolios. The TSX-listed asset allocation ETFs hold plenty of Canadian and foreign securities, so it could still be a core registered investment, providing most of the needed exposure to the big two asset classes of stocks and bonds/cash. But leave a little room for alternatives.

As for inflation-linked bonds, the Canadian equivalent of TIPS are Real Return Bonds. For TIPS, you can hold the Vanguard Short-Term TIPS ETF (VTIP on the Nasdaq) or Canadian-dollar hedged, TSX-listed short-term TIPS ETFs from BMO, iShares and others.

But even these are no panacea. Ardrey points out: “Some may feel that real return—or inflation-linked—bonds are the way to get around this. The problem with buying these types of bonds is they are at a premium, which reduces the yield you ultimately can earn on them.”

Other investments to consider for the mix

Some investors may want to add (real estate or real estate investment trust) REIT ETFs, perhaps in place of some stocks or commodities.

Younger investors may prefer to use cryptocurrencies at the expense of some or all of the 7.5% gold holding. Begin with a split between bitcoin and ethereum ETFs. There are hundreds more cryptos. I personally wouldn’t touch them.

Adding in other non- or low-correlated asset classes, like commodities and real estate, is part of the plan. Ardrey agrees: “The other is to add alternative investments. These investments typically focus more on the private market than the public in areas like company debt, mortgages and REITs. The aim for most of these investments is to earn 7% to 9% per annum net of any investing costs.”

Canadians and the 60/40 mix

However, Adrian Mastracci, portfolio manager with Vancouver-based Lycos Asset Management, is not convinced investors need much more than a 60/40—or 70/30—basic portfolio along the lines of what the asset allocation ETFs provide. He says Canadian investors with index exposure to the domestic market will own lots of equities exposed to commodities and gold in any event. “My view is to keep it simple, be patient and embrace your long term strategy.”

The problem with holding a mix of uncorrelated or partially uncorrelated asset classes is that inevitably some of them will be falling as others rise. If you focus on the losing positions and fail to look at the portfolio as a whole, you could end up hurting your long-term returns.

The bottom line

It may help to remember that an investment portfolio, in its entirety, is not likely to be your entire wealth. While investors may try some Dalio-type tweaks to cover off some of the less probable economic outcomes, there’s no guarantee you’ll sleep as soundly as someone who entered an inflation-linked defined benefit pension plan in their youth and held on until retirement. Even without gold-plated employer pensions, most will receive the guaranteed inflation-linked pensions Ottawa makes available in old age, Canadian Pension Plan (CPP) and Old Age Security (OAS), and for the most vulnerable the guaranteed income supplement (GIS).

MoneySense Investing Editor at Large Jonathan Chevreau is also founder of the Financial Independence Hub, author of Findependence Day and co-author of Victory Lap Retirement. He can be reached at [email protected].

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About Jonathan Chevreau

As MoneySense’s Investing-Editor-at-Large, he is also author of Findependence Day and co-author of Victory Lap Retirement. Reach him at [email protected], where he is the founder of Financial Independence Hub.