A Dozen Things I’ve Learned from Ray Dalio about Investing

1.  “The economy is like a machine.” The bottoms-up way Ray Dalio approaches the economy is analogous to value investing.  You start with the simplest possible system since that is the easiest system to understand. For a value investor that relatively simple system is an individual company. Dalio starts instead with the simplest part of the economy which is the transaction and then build his models bottoms-up. To do the reverse (adopt a top-down approach) is to start with a nest of complex adaptive systems which makes market outperformance after fees impossible. Ray Dalio is humble about his bottoms-up process and so has adopted an approach where he invests in 15 uncorrelated macro trends at a time so he is diversified.  In making 15 bets on macro trends, Dalio has built the case for each bet from micro (bottoms-up) foundations.

2. “Alpha is zero sum. In order to earn more than the market return, you have to take money from somebody else.”  John Bogle makes the same point and adds that fees must be considered as part of this inevitable math.  You are not going to beat people who invest as a profession by spending a few minutes or even a few hours a week looking at Yahoo Finance.

3. “If you’re going to come to the poker table, you’re going to have to beat me. … We have 1500 people who work at Bridgewater. We spend hundreds of millions of dollars on research and so on, we’ve been doing this for 37 years.”   Ray Dalio can build his bottoms-up “machine” model of the economy better than others because, as Paul Volker once noted, Bridgewater “has a bigger staff, and produces more relevant statistics and analyses, than the Federal Reserve.” The idea that other investors are going to beat Ray Dalio at this game is folly. Why don’t macroeconomists do what Ray Dalio does? Because macroeconomists don’t have the bottoms-up data that Ray Dalio has at Bridgewater, so they adopt math driven models that are built on in fake assumptions. Unsurprisingly, the top-down macroeconomic models have less than zero ability to outperform the market.

4. “It all comes down to interest rates. As an investor, all you’re doing is putting up a lump-sump payment for a future cash flow…. The big question is:  When will the term structure of interest rates change? That’s the question to be worried about. .. He who lives by the crystal ball [in trying to forecast interest rates] will eat shattered glass.”  When you stop thinking you can forecast interest rates (especially in the short term) you are essentially no longer hitting your thumb repeatedly with a large metal hammer.  Your financial life gets a lot more attractive.

5. “The nature of investing is that a very small percentage of the people take money, essentially, in that poker game, away from other people who don’t know when prices go up whether that means it’s a good investment or if it’s a more expensive investment.  Too many investors are reactive decision-makers. If something has gone up, they say, ‘Ah, that’s a good investment.’ They don’t say, ‘That’s more expensive.'” Price is what you pay and value is what you get. Sometimes a great company has shares that are a poor value in terms of price. If you are patient, the bi-polar Mr. Market usually will send those prices down so the purchase becomes attractive.  Until then, wait.

6. “The biggest mistake investors make is to believe that what happened in the recent past is likely to persist. They assume that something that was a good investment in the recent past is still a good investment. Typically, high past returns simply imply that an asset has become more expensive and is a poorer, not better, investment.” Nothing good or bad goes on forever.  Business cycles are inevitable. Dalio has devoted an entire video explaining his views on business cycles.

7. “The most important thing you can have is a good strategic asset allocation mix. So, what the investor needs to do is have a balanced, structured portfolio – a portfolio that does well in different environments…. we don’t know that we’re going to win. We have to have diversified bets.”  The most important words here are” we don’t know if we are going to win.” The future is a probability distribution.

8. “Bonds will perform best during times of disinflationary recession, stocks will perform best during periods of growth, and cash will be the most attractive when money is tight. Translation: All asset classes have environmental biases. They do well in certain environments and poorly in others. “

9. “Owning the traditional equity-heavy portfolio is akin to taking a huge bet on stocks and, at a more fundamental level, that growth will be above expectations…. Levering up low-risk assets so you can diversify away from risky investments is risk reducing.”  This is a fundamental part of Ray Dalio’s “risk-parity” approach.  The leveraging of bonds in the fund has benefitted from the decades long bond bull market which has at least been a major side benefits of the risk-parity approach.

10. “There are two main drivers of asset class returns – inflation and growth… you can’t have debt rise faster than income. You can’t have income rise faster than productivity and the long term growth will be dependent on productivity.

11. “Risky things are not in themselves risky if you understand them and control them. If you do it randomly and you are sloppy about it, it can be very risky.” Ray Dalio is making the same point Warren Buffett makes when he says:  risk comes from not knowing what you are doing. Invest in your circle of competence.

 12. “You’re not going to win by trying to get what the next tip is – what’s going to be good and what’s going to be bad. You’re definitely going to lose.”  See my post on Howard Marks  https://25iq.com/2013/07/30/a-dozen-things-ive-learned-about-investing-from-howard-marks/

7 thoughts on “A Dozen Things I’ve Learned from Ray Dalio about Investing

  1. Really enjoying your posts. Regarding Dalio, you just can’t leave this one out (from Hedge Fund Market Wizards, Jack Schwager):

    [Dalio walks over to the board and draws a diagram where the horizontal axis represents the number of investments and the vertical axis the standard deviation.] This is a chart that I teach people in the firm, which I call the Holy Grail of investing. [He then draws a curve that slopes down from left to right—that is, the greater the number of assets, the lower the standard deviation.] This chart shows how the volatility of the portfolio changes as you add assets. If you add assets that have a 0.60 correlation to the other assets, the risk will go down by about 15 percent as you add more assets, but that’s about it, even if you add a thousand assets. If you run a long-only equity portfolio, you can diversify to a thousand stocks and it will only reduce the risk by about 15 percent, since the average stock has about a 0.60 correlation to another stock. If, however, you’re combining assets that have an average of zero correlation, then by the time you diversify to only 15 assets, you can cut the volatility by 80 percent. Therefore, by holding uncorrelated assets, I can improve my return/risk ratio by a factor of five through diversification….I strive for approximately 100 different return streams that are roughly uncorrelated to each other. There are cross-correlations that enter into it, so the number works out to be less than 100, but it is well over 15.

    And restated here with Erik Schatzker, starting at minute 4. http://www.youtube.com/watch?v=uU9fmO0_oLI

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  6. Nice list. FWIW, the 15 non correlated asset idea is also worthwhile. I guess you touch on it. It occurs to me a way for the average retail guy to invest in leveraged low risk assets is closed end municipal funds for taxable, closed end high investment grade for non-taxable. Looking fwd to reading your Howard Marks list. Best, Doug W.

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