Risk contribution vs capital weight

A friend showed me his "balanced" portfolio on Saturday. 60 percent equity, 40 percent debt. He liked the symmetry of it. Felt safe. Felt diversified.

So I ran the actual risk on it. The 40 percent sitting in debt was carrying about 6 percent of the real risk. The equity sleeve was carrying the other 94. His balanced portfolio was an equity portfolio wearing a seatbelt made of paper.

Here is the part nobody tells you. Capital weight and risk weight are two completely different things. Rupees tell you what you own. Volatility tells you what you are actually betting on. Equity swings about 18 percent in a year. Debt swings about 5. So a single rupee of equity carries far more risk than a single rupee of debt, and the risk piles up wherever the swings are, not wherever the money sits.

Run the same book three ways and the gap is almost comic. Split the capital 80/20 and equity carries 98 percent of the risk. Split it 60/40 and equity carries 94. To get debt to actually carry half the risk, you have to hold barely a fifth of your money in equity, somewhere near a 22/78 split. The 40 percent debt sleeve was never the brake the brochure implied. It softens the fall a little. It does not split the risk.

The honest version: 60/40 is a marketing ratio, not a risk decision. A diversifier only diversifies if it is large enough and different enough to move the only number that hurts you, the drawdown. Size the split by the fall you can actually sit through, not by the round number that sounds even.

A 60/40 portfolio is a 94/6 bet with better branding. Size the risk, not the rupees. The market moves the risk and never once reads the label.

How risk really splits inside a portfolio: