“I know that the key to my success has not been so much what I know as much as how I deal with my not knowing,” writes Ray Dalio in his recently published book “Principles: Life and Work.” Ray Dalio is perhaps the most successful hedge fund manager in history. He built Bridgewater Associates from the ground up to later become the largest hedge fund in the world. A year ago, he and Bridgewater had 150 billion dollars in assets under management (AUM) and employed over 1,700 workers. Dalio became billionaire and appeared on a prominent spot in the Forbes 500 list of the world´s most wealthy individuals. And maybe even more important to our readers, Ray Dalio invests 15% of his “All Weather” fund in gold. But Dalio was not always as successful as today. As he explains himself, he foresaw and predicted the Mexico-crisis of 1982. Eventually the Mexican governments went, as he predicted, bankrupt. But to his very surprise, the market did exactly the opposite of what he anticipated: the stock market bottomed out and began to rise, whereas Dalio expected a crisis and a stock market crash. As his bet on a crash was considerable, he began losing money and ended up being forced to fire his entire staff, which he described as “family,” and at a certain point even borrowed 4000 dollars from his dad to make ends meet. Ever since, the hedge fund manager has been obsessed with avoiding mistakes at any cost. In our section here, we often anticipate and try to foresee future events. How can we apply the lessons of Ray Dalio to increase the odds of being right?
Ray Dalio says he went from “thinking he is right” to “thinking how he knows whether he is right,” a fundamentally different approach to investing.
“Only two things that you need to do in order to be successful. The first is you have to know what the right decisions to make are, and then you have to have the courage to make them. And most people don't have in their head the right decision. And I think one of the greatest tragedies of man is that they hold onto opinions in their heads that are wrong, and they don't go out there and stress test them.”
But how do you go about stress testing your ideas?
One of Ray Dalio’s methods is to simply surround yourself by people who hold different opinions or viewpoints and then create an environment of, what Ray Dalio calls, “radical truth” and “radical openness.” Of course, you yourself are responsible for whatever decision you end up making. And for many (retail, non-professional) investors I have spoken to over the years, making decisions is precisely what people find difficult. But Ray Dalio, by exposing himself, his ideas and his investment theses to critique, while being completely intellectually honest with yourself (“radical truth”), one can find out wherever his reasoning falls short. Ray Dalio described his initial experiences in the following way:
“The smartest people who disagreed with me, and to see how they would think about things, to balance my bets better. It taught me a radical open-mindedness. It taught me what you're referring to in the beginning of the book that I'm trying to convey, that the power of radical open-mindedness and an idea meritocracy is such a powerful thing.”
Dalio tried to introduce this culture of “radical openness” and “radical truth” in his fund. Many from outside the fund came to criticize Bridgewater’s culture, which is often characterized as mean, cold, heartless and offensive. Dalio himself briefly commented that some get too carried away in this culture of openness and become mean. But, in general, his question is justified: do we prefer that others tell us the truth so that we might improve and correct our behavior or opinions or do we rather prefer that they do not? Although criticism can hurt emotionally (it might be hard to receive direct criticism), you are better off if you can cope with this type of radical openness.
Another very successful investor, Seth Klarman, does something very similar. He assumes that the market is always smarter than himself. And that is why he forces himself to know exactly why the market thinks that an investment is worth its current price. In what sense does his judgment differ from the market´s? Do others know something that he himself does not know? Investing becomes almost a quest of rational self-doubt.
But even then, it might be impossible to weed out every single wrong investment thesis. The only mistake which Ray Dalio warns of is, therefore, putting all your eggs into one basket or taking irresponsible single bets. Of course, diversification is a dangerous opposite. But holding concentrated positions does not mean having 100% of your funds invested in one single position. When one single position is able to reduce your net worth by half, then you might be overexposed to that single position. Being invested in gold for a full one hundred percent is perhaps too much of a good thing, but being invested for twenty-five percent, for example, is still a very concentrated position, while the risk that your entire net worth is turned upside down is seriously reduced.
The old stock market wisdom of “being too early is the same as being wrong” is not entirely true. Actually, it is better to be early than late. I recommend reading this article which I wrote earlier, in which I prove that in an entire decade the best ten trading days (with the highest positive daily returns in gold) are decisive when it comes to a long-term compound return. In other words, if we are too early, we are sure to not lose out on those days. If we, however, think we can “time” the market, then the odds are that we will miss out on one or various of such rare trading days.
A good example is, yet again, Seth Klarman: he recognized and explicitly referred to the dotcom bubble as early as in 1996 (!). As a result, he took the decision to reduce his exposure to the US stock market considerably. For five long years, Seth Klarman seemed senile or even insane, especially when he publicly defended his position while underperforming the market. But after five tough years, one of the biggest stock market crashes and bear markets ever happened and Klarman was proven right. Despite five difficult years, his fund, Baupost Group, returned an amazing 17% on average annual basis. Was Klarman so mistaken by being early? We now know he wasn’t.
To close, I leave you with the following video, in which author Tony Robbins interviews Ray Dalio: