What is Risk Parity?
A normal portfolio might put 60% in stocks and 40% in bonds by dollar value. But stocks are far more volatile — so the 60% in stocks contributes 90%+ of the total risk. Risk Parity flips this: instead of equal dollar weights, it allocates so that every asset contributes an equal share of the total portfolio volatility. Lower-volatility assets get higher weights. Higher-volatility assets get lower weights.
Weight(i) = (1 / σ(i)) / Σ(1 / σ(j)) · where σ = annualised volatility of each asset
Why it matters
Used by Ray Dalio's Bridgewater in the famous All Weather Portfolio. The idea: no single asset dominates the risk. During a crash, the low-volatility assets (bonds, gold) hold up the portfolio while equities fall. During a boom, equities lead. The result is a smoother ride with lower drawdowns.