Two Companies, Two Philosophies
Two companies that have had an enormous hand in shaping our culture are directly responsible for you reading these words.
Microsoft and Apple. Two companies, both working in the same field, but with fundamentally different philosophies and approaches.
One believed that computers should be open-source, with individuals able to write their own programs, to tinker with them. This democratization of the desktop computer helped establish Microsoft as a leader in personal computing, making the power of the electronic age accessible to normal people.
The other believed that user experience should be cultivated from beginning to end. Without outside input, the company sought to control how each person interacted with their computers. Due to this Apple was able to engineer a truly unforgettable experience for its customers. From the in-store experience, to the sensation of holding a new laptop with its beveled edges (which others sought to replicate), to the seamless integration with its other products, Apple developed raving fans.
And while it might seem that one company’s success would sink the other’s hopes, they both thrived. They both gained a following, because they held different goals. They were both right.
Photo by Austin Distel on Unsplash
LDI vs Risk Parity
In the investment world, two investment strategies have gained a following.
The first, Risk-Parity, seeks to decrease the risk to one’s assets as much as possible no matter what is happening in the economy. Its proponents include Ray Dalio, founder of the world’s largest hedge fund.
The other, Liability Driven Investing, or LDI, seeks to gain enough assets to cover all current and future liabilities. Its proponents are Robert Merton and Dimensional Fund Advisors.
These different goals mean that they will suit different people.
What is Risk Parity
Ray Dalio offered the world a huge insight into how he views things when he revealed his “All Weather Portfolio.” This portfolio’s breakthrough was balancing the levels of risk that different asset classes have.
The All-Weather Portfolio seeks to decrease volatility in any economic season, whether inflation and growth are each higher or lower than expected.
In this portfolio, 7.5% becomes allocated towards Gold, seeking to protect investors against times when growth are low and inflation is high. Because of Ray Dalio's most recent remarks, it seems like he's starting to see cryptocurrency as a tool that is very similar to Gold - a "storehold of wealth" that can protect against inflation. It's possible that people will start to use cryptocurrency as one of their investments when using this All-Weather Portfolio.
Large institutions who know their time horizons are measured in decades can make great use out of this type of portfolio. Over a long period of time, the decreased volatility pays off major dividends.
However, the All-Weather Portfolio does not take into account more short term needs that an individual might have. Withdrawals made from this type of portfolio can decrease its effectiveness.
For those individuals, a Liability-Driven approach might be more suitable.
What is LDI?
Dimensional Fund Advisors champions LDI. When considering what types of liabilities it takes into account, they consider any debts owed, as well as any money that will need to be withdrawn to cover ordinary expenses. This is what makes LDI their favorite strategy for retirement readiness.
Instead of having a portfolio broken into pieces by stocks, bonds, and gold commodities, LDI focuses its efforts on generating income for an individual during their retirement. Thus, as the individual gets closer to retirement, the portfolio begins to weight more heavily towards bonds, and away from stocks.
Since cryptocurrency produces no cash flow to provide income for retirees, those using an LDI approach will be less likely to include cryptocurrency as part of their portfolio.
So which is better?
As you can see, Risk-Parity and LDI have different goals and outcomes, just like Microsoft and Apple. And the beauty of the economy is that both are correct, and both can work.
Choosing between these two for an individual requires an examination of the person’s goals, time horizon, and spending habits. A financial advisor can help you objectively decide which would be more suitable for your situation.
If you’re interested in investing, but not sure where to start, click here to book a complimentary meeting with one of our advisors today.