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Holly LaFon
Holly LaFon
Articles (10163)  | Author's Website |

Ray Dalio's Latest: Risks Are Rising While Low Risks Are Discounted

There are returns, and there are risks

August 11, 2017 | About:

There are returns, and there are risks. We think of them individually, and then we combine them into a portfolio. We think of returns and opportunities as coming from those things we’d bet on, and we think of risks as the adverse market consequences of us being wrong due to our being out of balance. We start with our balanced beta portfolio—i.e., that portfolio that would most certainly fund our intended uses of the money. Everyone should have their own based on their own projected uses of money, though more generally, it’s our All Weather portfolio. We then create a balanced portfolio of opportunity/alpha bets based on what we think is likely to happen. We then combine them.

We bet on the events/outcomes that we think we have an edge in understanding. For events/outcomes where we don’t think we have a particular edge—e.g., political events—we aim to construct our portfolio to be relatively neutral or balanced to those risks.

Risk and Volatility

As a rule, periods of lower risk/volatility tend to lead to periods of greater risk/volatility. That is reflected in our aggregate market volatility gauge (see below), and markets are pricing in volatility to remain low next year too.


As a related rule, people adapt to the circumstances they have experienced and are then surprised when the future is different than the past. In other words, most people are inclined to assume that the circumstances they have recently encountered will persist, which leads them to change what they are doing to be consistent with that recently experienced environment. For example, low-volatility periods in which credit is readily available tend to lead people to assume that it’s safe to borrow more, which leads them to lever up their positions, which contributes to greater volatility and hurts them when things change.

That appears to be the case now—i.e., prospective risks are now rising and do not appear appropriately priced in because of a) a backward looking at risk and b) corporate leveraging up has been high because interest rates are low relative to many companies’ projected ROEs and because past risks have been low. The emerging risks appear more political than economic, which makes them especially challenging to price in. Most immediately, during the calm of the August vacation season, we are seeing 1) two confrontational, nationalistic, and militaristic leaders playing chicken with each other, while the world is watching to see which one will be caught bluffing, or if there will be a hellacious war, and 2) the odds of Congress failing to raise the debt ceiling (leading to a technical default, a temporary government shutdown, and increased loss of faith in the effectiveness of our political system) rising. It’s hard to bet on such things, one way or another, so the best that one can do is be neutral to such possibilities.

When it comes to assessing political matters (especially global geopolitics like the North Korea matter), we are very humble. We know that we don’t have a unique insight that we’d choose to bet on. Most importantly, we aim to stay liquid, stay diversified, and not be overly exposed to any particular economic outcomes. We like to hedge our bets, though we are never completely hedged. We can also say that if the above things go badly, it would seem that gold (more than other safe haven assets like the dollar, yen, and treasuries) would benefit, so if you don’t have 5-10% of your assets in gold as a hedge, we’d suggest that you relook at this. Don’t let traditional biases, rather than an excellent analysis, stand in the way of you doing this (and if you do have an excellent analysis of why you shouldn’t have such an allocation to gold, we’d appreciate you sharing it with us).

About the author:

Holly LaFon
I'm a financial journalist with a Master of Science in journalism from Medill at Northwestern University.

Visit Holly LaFon's Website

Rating: 5.0/5 (2 votes)



LGODKIN - 3 years ago    Report SPAM

What do you think of hedging with cryptocurrencies instead of gold?

Jmannsch premium member - 3 years ago
At the end of the second-quarter, gold and gold mining stocks made up less than 2% of Ray Dalio (Trades, Portfolio)' portfolio. Perhaps he is buying these investments in the third quarter and they have not made it yet to his current portfolio list

Jeremieroy premium member - 3 years ago

hedging with cryptocurrencies?! Why not hedging with dog shit while we're at it?

LGODKIN - 3 years ago    Report SPAM

hedging with cryptocurrencies?! Why not hedging with dog shit while we're at it?

Are gold and bitcoin all that different? Both are traded as investments and can be considered to be a store of value. They have about the same importance in the real world. Besides in small quantities in computer equipment and other applications, gold has little industrial value. Bitcoin can be used to purchase real world items and is considered legal tender in Japan & Australia, but shares of GLD are accepted nowhere as a form of payment and currencies are no longer backed by gold. From 2013-2016 GLD had a CAGR of -9..31% and BTC had a CAGR of 81.71%. Which one would you have liked to owned?

Perhaps BTC and other cryptocurrencies are the new tulips and their value will come crashing down, or perhaps they will become the new gold to a generation distrustful of governments and centralized banking. If cryptocurrencies are not at least a small part of your portfolio, then you're not properly hedged for the future.

Jeremieroy premium member - 3 years ago

lol 1- what is your big insurance that cryptos will not come crashing down with the rest when interest rates will reach a certain level? 2- Cryptos price have reached all time highs more over hype and than actual utilisation so a correction of the price is eventualy almost certain 3- There is no better hedging than buying undervalued securities

MoneyGenerationXYZ.com - 3 years ago    Report SPAM

Jeremieroy you would be unwise to think that undervalued stocks are a hedge, check out the blog post below... from the experience of Ben Graham himself.


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