Ray Dalio (Trades, Portfolio) is the founder of Bridgewater Associates, one of the world’s largest and most successful hedge funds, and has spent more than 40 years making a killing in the capital markets. On Nov. 19, Dalio sat down with Bloomberg’s Barry Ritholtz to discuss his views on life and investing.
Let’s see what Dalio can teach us about the art and science of investing in his latest interview.
On structured reasoning
“Everybody would benefit enormously by being crystal-clear about their principles ... if you write down your criteria for making decisions in words, that allows you to clarify your decision-making, and you can take in from others what the best criteria is for those circumstances in the future.”
The lesson here is to standardize your thinking, which will allow you to tweak and alter it as you see fit by taking the best parts of different people’s reasoning. Is your portfolio sufficiently diversified? Are you too conservative in your picks? What is your risk/reward profile? How do you react to losses? By modularizing your investment approach and breaking it down to individual questions like this, you can change individual parts of it until you arrive at an optimal process. Dalio went on to stress that his principles are not necessarily the right ones for everyone and that the best course of action is to work out what works specifically for you.
On embracing "idea meritocracy"
“I want an idea meritocracy ... I want the best ideas to win ... it doesn’t have to come from me, I just want the best decisions to be made. The markets discount the consensus, so in order to be successful in the markets you have to think independently.”
The importance of independent thinking is repeated so often by investment professionals that it has almost become a cliche at this point. But notice that Dalio is not just saying that independent thinking is important. What he is talking about here is the importance of humility and a willingness to accept that other people will often have better ideas than you. This means being flexible in the face of changing market conditions and not becoming wedded to losing positions. A successful investor must care more about being rich than being right.
On debt cycles and market exuberance
“In the last cycle, we brought interest rates basically down to zero - that wasn’t good enough, so central banks bought $15 trillion worth of assets, pushed the asset prices up, pushed liquidity into the system and so asset prices go up and people extrapolate. And the funny thing about it is: as you get later in the cycle when there is more debt and you know you’re coming closer to the end of the cycle, there is more of an extrapolating in the market prices.”
What Dalio is talking about here is the tendency of price to outstrip value in the later stages of the business cycle. The lesson here is that by looking at macroeconomic variables like interest rates and levels of corporate debt, as well as stock-specific indicators like price-earnings ratios, the prudent value investor can recognize late-cycle markets that become uncoupled from economic reality. This is quite similar to Buffett’s old adage: “Be fearful when others are greedy, and greedy when others are fearful.”
On mental blind spots
“The most important thing, as you’re young, is that your success comes from knowing how to deal with your not knowing, more than it comes from anything that you know.”
Although this advice was aimed primarily at young people seeking a career in finance, the core principle can be applied to investing in general. Understanding that you cannot know everything, and remaining cognizant of your mental blind spots will help you to avoid hidden pitfalls, even if you do not know exactly what those pitfalls are. Beware of overconfidence, as it can leave you vulnerable to new market challenges that you may not have encountered in the past.
Watch the full interview and Q&AĂ‚ here.
(This article was co-authored by Stepan Lavrouk, director of research at Atreides Capital LLC and a former research analyst for Almington Capital Merchant Bankers.)
Disclosure: No positions.
