Ray Dalio on the Latest Addition to His ‘Principles’ Series, and How to Invest Today

Ray Dalio, legendary investor and New York Times bestselling author, has some advice for investors for what could be a choppy year—and why diversifying your portfolio can reduce your risk by about 80%.

Dalio joined Investpedia’s editor-in-chief Caleb Silver, on The Investopedia Express podcast to discuss why a well-diversified portfolio and understanding economic cycles can help investors reduce risk in times of volatility, and why you should have a systematic approach to the way you make decisions. 

Dalio has over five decades of experience navigating financial markets as a global macro investor, and is the co-founder of the world’s largest hedge fund, Bridgewater Associates. He is the author of the #1 New York Times Bestseller Principles: Life and Work and most recently, Principles: Your Guided Journal. Below is their edited conversation. 

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Return-to-Risk Ratio and Diversification Are the Key To Mitigating Risk 

Silver: If you had to think about putting money to work for the next 25 years, what are you thinking about as an investor, as a retail investor, who has access to the types of products me and my listeners do? 

Dalio:  Well, the most important things are, you’re not probably going to be able to compete in this market timing game because we put hundreds of billions of dollars in it, and it’s a tough game. 

The second thing is that the key is your return-to-risk ratio. Risk and diversification are of paramount importance, and the fact is that if you diversify well, you can reduce your risk by 70% or 80% if you take uncorrelated, good things.

And if you have the right diversified portfolio, that means you can increase your return-to-risk ratio by a factor of 5 by knowing how to diversify without reducing your returns. So finding good, uncorrelated return streams is of paramount importance.

Understanding History and Economic Cycles To Gain Insight Into the Market 

Silver: This all brings us to kind of where we are today, cycles repeating over and over again. How do we take the work that you’ve done and apply it to how we think today, both professionally and also as investors? 

Dalio:  In my books, I try to explain my understanding of the mechanics, the cause-effect relationships. So for example, there’s a short-term debt cycle and a long-term debt cycle. What do I mean by a short-term debt cycle? You know we’re in one of those. We’re always in one of those. 

That’s when the economy is in recession or weak, inflation is low. Then central banks produce money and credit. That causes the pickup. It carries it until inflation rises, and the economy’s hot. Bubbles occur, then they tighten money, and then that changes interest rates, which changes asset prices, and so on, and then you go through that. 

So that’s a cycle. They’ve lasted an average of seven years, plus or minus. You have to know where you are in that cycle. We know where we are in that cycle. You have to know how they work, and that affects your expectation of what markets and pricing will do. 

Why Identifying Your ‘Principles’ Will Help You Become a Better Investor 

Silver: You’ve boiled your life’s work and philosophy into this step-by-step process for anyone to follow. It’s a recipe, I like to call it, for self-improvement and actualization. But what brought you to that from where you began with Principles?

Dalio: When I started investing, I would think about how I would make decisions. And then I started to write down my criteria, and then I realized that if I specified them very clearly in equations, that I could go back-test them and see how they would have performed, and I learned a great deal from that. 

And I found that when I did those things, it brought me into a deeper way of thinking because almost everything happens over and over again. And all decisions are based on criteria that are in our heads. And so I did that with every aspect of life. In a lot of that I systemized the decision-making in terms of these equations so that the computer could help me and help Bridgewater in making those decisions. 

And then writing down these principles, which are essentially the criteria for making decisions, the recipe, so to speak. And that made me think in a better way, made me more systematic, made me communicate better to those I was operating with. So that was the background of all these principles. 

Dalio’s Favorite Investing Terms: Diversification and Financial Engineering 

Silver: What’s your very favorite investing term and why? 

Dalio: Well, I guess it would be diversification. 

Everybody pays attention to returns, and they don’t pay attention to risks as much. And that’s one of the reasons we’ve been successful because think of it this way. If you lose 50%, you’ve got to make 100% to get back. 

I think the most we’ve ever lost in a year was 13%, and that was the COVID year because the controlling of risk with diversification, the right balancing, and perhaps some leverage, is something that produces the best results. 

And maybe the term is also financial engineering. But when I mean financial engineering, I don’t mean go into an optimizer and throw things around and see what spits out. I mean understanding the parts and how to put those parts together. I think that those would be my buzzwords, diversification and financial engineering, I think. 

The Bottom Line: 

Having a well-diversified portfolio and knowing your principles for decision making are essential for becoming a smarter and stronger investor, according to Dalio. 

This set of rules for how you make decisions—or the ‘recipe’ as Dalio calls it—will help you weather tough economic storms, and can help you achieve your goals, financial and otherwise. 

Dalio says that ultimately, none of it is new—and like many things in life, the economy goes through its cycles, too. By observing and understanding these economic cycles, we can be better prepared to face them. 

“It’s like a doctor watching the same thing happen over and over again. It gives me the perspective that I need. And this isn’t theoretical—this is for dealing with what’s going on right now.”