What is most interesting to me about Ray Dalio is his decision-making process. This blog post is limited to a discussion of that process and not Bridgewater’s philosophy generally. If you are interested in understanding Bridgewater and Dalio more broadly, Dalio has a book coming out this fall which expands on his widely circulated “Principles” document. I have written a more general blog post about Dalio on this blog, which you can find a link to in the Notes to this post.
Anyone who has read and understood the books and essays of Michael Mauboussin knows that people who have a sound decision-making process have better outcomes in life (not just in investing). Dalio’s view tracks Mauboussin’s view: “I think that every single day there are many decisions that people make and they all have consequences. And your life essentially depends on the cumulative quality of the decisions you make.” Having said that about the importance of making wise decisions in all aspects of life, thinking about how Dalio makes investment decisions is a particularly effective way of understanding his process. These quotations from Dalio set the table for a discussion of his decision-making process:
“You have to be an independent thinker in markets to be successful because the consensus is built into the price. You have to have a view that’s different from the consensus.”
“To win at stocks or entrepreneurship, you must bet against the consensus and be right.”
Andy Rachleff makes the same point as Dalio is saying in this way: “Investment can be explained with a 2×2 matrix. On one axis you can be right or wrong. And on the other axis you can be consensus or non-consensus. Now obviously if you’re wrong you don’t make money. The only way as an investor and as an entrepreneur to make outsized returns is by being right and non-consensus.”
Another adherent to this idea is Howard Marks who has said: “To achieve superior investment results, your insight into value has to be superior. Thus you must learn things others don’t, see things differently or do a better job of analyzing them – ideally all three.” Being genuinely contrarian means the investor is going to be uncomfortable sometimes. Some people are good at being uncomfortable, and some are not.
“Most other professions you can build on existing knowledge. You don’t have to have a point of view. If you’re a doctor and somebody breaks a leg or whatever, you can repair that leg. It’s not zero-sum, in the sense that you have to be smarter than the next person or different from the consensus. Now in order to be different from the consensus, there’s a high risk you’re going to be wrong.”
“Find people of alternative points of view and have quality conversations back and forth. Not to let them think for me, not for me to follow their point of view, but for me to understand the different perspectives. Because it increases my probability of being right, and it reduces my probability of being wrong.”
“When you have a view that’s different from the consensus, you’re gonna be wrong a certain number of times. It teaches you humility. The most important thing is to have humility and to think about ‘how do I get the best decision?’ It doesn’t have to come from me, I just want to be right.”
“Decision-making should be two steps. The first step is taking in information, particularly if there is disagreement, to understand that disagreement and then to make a decision. You have your right to make a decision. But it is so stupid not to take the time to take in and explore disagreement that might help prevent yourself from being wrong.”
The desire to explore disagreement is the foundation of Dalio’s drive to create “radical transparency”? Dalio describes this concept as follows:
“I want an idea meritocracy. I want independent thinkers who are going to disagree. The most important thing I want is meaningful work and meaningful relationships and the way to get that is through radical transparency.”
“Meaningful work is being on a mission that you’re excited about and that you can get your head into. And in meaningful relationships you can be totally transparent with each other, letting each other know what your weaknesses are.”
As context, what Dalio is setting out to do as an investor is extraordinarily hard. To say that a tiny number of people outperform the markets by making macro bets is a radical understatement. A handful of people have been able to do this successfully over many years at scale. Dalio has discovered a source of alpha (outperforming a benchmark) through a process that results in better decisions.
Here is my short “boil the ocean” description of his decision making process: Dalio starts with a rational analysis of the information he has and from that he forms a hypothesis. He then exposes that hypothesis to thoughtful people with alternative points of view and methods of analysis who may disagree with him and then he wants a radically transparent “back and forth” discussion. As part of that process he wants to deeply understand the reasoning of any thoughtful opposing views. Only after he has understood these alternative points of view does Dalio believe he is in a position to reject or accept the alternative ideas and make a decision. Dalio’s approach is quite similar to Charlie Munger’s approach: “I never allow myself to have an opinion on anything that I don’t know the other side’s argument better than they do. Rapid destruction of your ideas when the time is right is one of the most valuable qualities you can acquire. You must force yourself to consider arguments on the other side.”
Why would Dalio join Twitter this week? Well, if you do use Twittter properly you can get exposed to real time views of smart people who think differently and who may have opposing views. He seems to understand a key point about Twitter’s value when he tweeted this past week: “Look forward to learning from my mistakes in a whole new way.” Bob Lefsetz explains why Twitter is so unique:
Many people treat Twitter as a broadcast medium which is a shame since the value of interactive discussion is so much higher. Many people also turn their Twitter feed into a echo chamber, which is a lost opportunity. Jason Zweig has a great column this week where is describes why “Investors have a hard time looking the truth square in the face” and the creation of echo chambers of all kinds makes the problem worse.
Dalio and Munger share other approaches to decision-making. For example, Munger, who describes his process as follows: “I use a kind of two-track analysis. First, what are the factors that really govern the interests involved, rationally considered? The first track is rationality-the way you’d work out a bridge problem: by evaluating the real interests, the real probabilities and so forth. Second, [I work to eliminate] influences where the brain at a subconscious level is automatically doing these things-which by and large are useful, but which often malfunctions.” Munger and Buffett also have a third step in their decision-making process that is similar to Dalio: expose their ideas to the best minds they can find. In Buffett’s case that mind is almost always Charlie Munger. Buffett calls Munger the “Abominable No Man.” Buffett exposing an investing hypothesis to Munger is like tempering steel if an investing hypothesis doesn’t break after being exposed to Munger it is more likelky to be sound.
Having a diverse “posse” of experienced people that you trust look at a potential investment is wise if you want to avoid making too many mistakes. Philip Fisher, an investor who Munger and many other investors learned a lot from, maintained a “scuttlebutt” network of people who he would call for advice or expertise, Munger has said: “Even Einstein didn’t work in isolation. But he never went to large conferences. Any human being needs conversational colleagues.” Buffett once gave a huge compliment to Munger’s value as a person who can stress test his ideas when he said: “I try to look out 10 or 20 years when making an acquisition, but sometimes my eyesight has been poor. Charlie’s has been better; he voted ‘no’ more than ‘present’ on several of my errant purchases.”
To review what I have said in this post so far, the decision making process that Dalio, Buffett and Munger use is:
(1) make the most rational decisions you can;
(2) look for psychological bias that may have interfered with making a rational decision; and
(3) expose your hypothesis to very smart people who have a thoughtful contrary view and deeply understand their position.
On this last point Daniel Kahneman believes: “To better avoid errors, you should talk to people who disagree with you and you should talk to people who are not in the same emotional situation you are.”
Dalio believes that the more a person repeats this process over the years, the more they learn. What does this sound like to you? It is essentially what Munger calls “Worldly Wisdom.” Dalio sounds very much like Munger here:
“What I’ve discovered in that process is that I was learning so much. So just imagine what a fantastic path to think.” “Let me go after the person who has got the opposite point of view, who is really smart, and let me have quality conversations, quality disagreement.” “I get clear feedback. The goal is: don’t be too wrong. Be more right than wrong. So in that process I can take personal accountability. If I don’t learn personal accountability, if I don’t learn, then I’m going to pay a terrible price. So that process itself lent itself to this kind of very open-minded decision. Also the making mistakes, and the loving the mistakes.”
“There’s an art to this process of seeking out thoughtful disagreement. People who are successful at it realize that there is always some probability they might be wrong and that it’s worth the effort to consider what others are saying — not simply the others’ conclusions, but the reasoning behind them — to be assured that they aren’t making a mistake themselves. They approach disagreement with curiosity, not antagonism, and are what I call ‘open-minded and assertive at the same time.’ This means that they possess the ability to calmly take in what other people are thinking rather than block it out, and to clearly lay out the reasons why they haven’t reached the same conclusion. They are able to listen carefully and objectively to the reasoning behind differing opinions. When most people hear me describe this approach, they typically say, ‘No problem, I’m open-minded!’ But what they really mean is that they’re open to being wrong. True open-mindedness is an entirely different mind-set. It is a process of being intensely worried about being wrong and asking questions instead of defending a position. It demands that you get over your ego-driven desire to have whatever answer you happen to have in your head be right. Instead, you need to actively question all of your opinions and seek out the reasoning behind alternative points of view.”
Dalio’s famous principles document provide a guide to decision making at Bridgewater. Many of these principles you have seen other investors say on this blog. For example:
“190) Recognize the Power of Knowing How to Deal with Not Knowing
191) Recognize that your goal is to come up with the best answer, that the probability of your having it is small, and that even if you have it, you can’t be confident that you do have it unless you have other believable people test you.
192) Understand that the ability to deal with not knowing is far more powerful than knowing a) Embrace the power of asking: ‘What don’t I know, and what should I do about it?’ b) Finding the path to success is at least as dependent on coming up with the right questions as coming up with answers.
193) Remember that your goal is to find the best answer, not to give the best one you have.
194) While everyone has the right to have questions and theories, only believable people have the right to have opinions
195) Constantly worry about what you are missing. a) Successful people ask for the criticism of others and consider its merit. b) Triangulate your view.
196) Make All Decisions Logically, as Expected Value Calculations
197) Considering both the probabilities and the payoffs of the consequences, make sure that the probability of the unacceptable (i.e., the risk of ruin) is nil. (a) The cost of a bad decision is equal to or greater than the reward of a good decision, so knowing what you don’t know is at least as valuable as knowing. (b) Recognize opportunities where there isn’t much to lose and a lot to gain, even if the probability of the gain happening is low. (c) Understand how valuable it is to raise the probability that your decision will be right by accurately assessing the probability of your being right. (d) Don’t bet too much on anything. Make 15 or more good, uncorrelated bets.”
What typically gets in the way of the process like Dalio wants to create? Ego and organizational politics.
A. The ego of the decision maker is so often the source of a problem or mistake. Dalio says that it is emotionally hard to be radically transparent. Warren Buffett writes: “It’s ego. It’s greed. It’s envy. It’s fear. It’s mindless imitation of other people. I mean, there are a variety of factors that cause that horsepower of the mind to get diminished dramatically before the output turns out. And I would say if Charlie and I have any advantage it’s not because we’re so smart, it is because we’re rational and we very seldom let extraneous factors interfere with our thoughts. We don’t let other people’s opinion interfere with it… we try to get fearful when others are greedy. We try to get greedy when others are fearful. We try to avoid any kind of imitation of other people’s behavior. And those are the factors that cause smart people to get bad results.” What Buffett describes is an example of what Charlie Munger calls inversion. Instead of just trying to be smart, it is wise to focus on not being stupid. Dalio believes:
“People are so attached to being right, and yet the tragedy is it could be so easy to find out how you’re wrong. If you just said to yourself, “I’m not sure that I’m right, and let me go find people who have alternative point of views and let me have quality conversations.” Not to pay attention to their conclusions, but to the thought process. So thoughtful discussion, worrying about being wrong but not to the sense of being paralyzed. Or moving forward, but in the sense of trying to create discovery, to have an exchange. To go after the person who has the most different point of view, who is the most thoughtful, and then have a conversation to see their point of view. Whether a person could be both open-minded and assertive at the same time, that creates a discovery process. It creates a fabulous learning. That process itself reduces the probability of being wrong and produces a great deal of learning. People are so hung up on being right. Starting their discussion and deriving some sort of satisfaction if, at the end of the discussion, they were where they began the discussion. That doesn’t make any sense, because there’s not going to be any learning. So ego plays an important role in that. The people that feel like, ‘I’m good. I’ve got it,’ won’t learn. If you’ve got it, you won’t learn. So you have to get rid of this ego barrier, ‘I’ve got it’ thing.”
“You start to learn how people see things differently. And rather than just seeing how you see it, you go above that. You’re seeing that everybody is seeing things differently. It changes how you see things because it starts to make you think, how do I know I’m not the wrong one? You start to think, how do I collectively see? And it’s like being in a different color range. All of the sudden you see the full spectrum. When you start to realize that people are actually seeing in those [different] ways — that it’s a valid way of seeing, and that I need you and you need me — it gives you the evidence base that it’s okay to be different. The most important thing is to have humility, and to think about, how do I get the best decision? It doesn’t have to come from me. I just want it to be right, right? If comes from other people, that’s good. The greatest tragedy of mankind is people holding on to wrong opinions that could so easily be rectified and that are doing them harm because they’re making wrong decisions.”
B. Organizational politics. One advantage that Buffett and Munger have is that in many cases the “radically transparent” discussion is just between the two of them. Both Buffett and Munger have said that they sometimes disagree but have never had “an argument” that was hostile. They have also decided to focus on investing decisions that involve forecasts about microeconomics. In contrast, Dalio is engaged in macro investing and his supporting organization is far larger. Reuters describes what must be managed at Bridgewater as follows:
“Bridgewater manages about $160 billion, according to its website, and is known for a unique culture of ‘radical truth and radical transparency’ whereby intellectual conflict is encouraged to promote a meritocracy of ideas, avoiding traditional office politics. The culture is not for everyone. The firm is known for relatively high turnover among its roughly 1,700-person staff. An estimated 25 percent depart during the first 18 months of employment.”
The challenges associated with maintaining a culture like Bridgewater which is willing to incur the overhead of continuously providing feedback and utilizing it in decision-making in an idea meritocracy are significant. The number of connections between employees increases with the square of the number of involved employees, which has caused Dalio to come up with some unusual approaches to maintaining radical transparency like videotaping and making available to anyone almost all meetings and the use of Bridgewater designed baseball cards. It is precisely because what Dalio is doing at Bridgewater is so hard that Bridgewater’s alpha has been persistent. If doing what Bridgewater does was easy, the alpha would disappear. Being different is a source of competitive advantage. If you want different results you must act in a different way.
To see how Dalio tries to combat dysfunctional corporate politics at Bridgewater it is useful to examine how he describes his principles:
“Never say anything about a person you wouldn’t say to him directly. If you do, you’re a slimy weasel. Badmouthing people behind their backs shows a serious lack of integrity. It doesn’t yield any beneficial change and it subverts both the people you are bad mouthing and the environment as a whole. Next to being dishonest, it is the worst thing you can do at Bridgewater. Criticism is both welcomed and encouraged at Bridgewater, so there is no good reason to talk behind people’s backs. You need to follow this policy to an extreme degree to be in harmony with our culture. For example, managers should not talk about people who work for them without those people in the room.” “So every meeting is taped and made available for everybody in the company to look at. And all we have are conversations of, ‘What makes sense?” Everybody has the right to make sense of things. Now in that environment I get to see how differently people think. I realize how radically different people think.” “This approach comes to life at Bridgewater in our weekly research meetings, in which our experts on various areas openly disagree with one another and explore the pros and cons of alternative views. This is the fastest way to get a good education and enhance decision-making. When everyone agrees and their reasoning makes sense to me, I’m usually in good shape to make a decision. When people continue to disagree and I can’t make sense of their reasoning, I know I need to ask more probing questions or get more triangulation from other experts before deciding. I want to emphasize that following this process doesn’t mean blindly accepting the conclusions of others or adopting rule by referendum. Our CIOs are ultimately responsible for our investment decision-making. But we all make better decisions by maintaining an independent view and the conflicting possibilities in our minds simultaneously, and then trying to resolve the differences. We’re always in the place of holding an opinion and simultaneously stress-testing the hell out of it. Operating this way just seems like common sense to me. After all, when two people disagree, logic demands that one of them must be wrong. Why wouldn’t you want to make sure that that person isn’t you?”
This sort of total honesty and transparency is not a comfortable environment for many people, but it is for enough talented people that Bridgewater has been able to assemble its team and compile its remarkable investing record. If you want to dig into radical transparency and issues like how ego and emotions can get in the way of Dalio’s approach to making decisions, I suggest you watch “The Culture Principle” video linked second in the Notes below.
The Culture Principle https://www.youtube.com/watch?v=h2KHec3KNyQ
Bridgewater Principles: https://docs.google.com/viewer?a=v&pid=sites&srcid=ZGVmYXVsdGRvbWFpbnxlYm9va3Nkb3dubG9hZG5vdzIwMTZ8Z3g6MjY3NGU2Njk5N2QxNjViMg and https://www.bridgewater.com/#principles-culture
New Yorker Profile: http://www.newyorker.com/magazine/2011/07/25/mastering-the-machine
A Dozen Things Essay by me about Dalio: https://25iq.com/2013/10/12/a-dozen-things-ive-learned-from-ray-dalio-about-investing/