فصل 5 بخش 1

SECTION 5

UPSIDE WITHOUT THE DOWNSIDE: CREATE A LIFETIME INCOME PLAN

CHAPTER 5.1

INVINCIBLE, UNSINKABLE, UNCONQUERABLE: THE ALL SEASONS STRATEGY

Invincibility lies in the defense.

—SUN TZU, The Art of War

There are events in our lives that forever shape our view of the world. Mile markers on our journey that, whether we knew it or not, have given us the lens through which we now see the world. And what we choose to allow those events to mean to us will ripple through our behavior and decision making for the rest of our lives.

If you grew up in the Roaring Twenties, your life was shaped by prosperity and grandeur. It was the days of the Great Gatsby. But if you grew up during the Great Depression, your life was shaped by struggle and anxiety. Growing up in a severe economic “winter” forced you to become a survivor.

Today’s generations have a completely different experience of the world. They have grown up in incredible prosperity, even if their incomes don’t land them in the 1%. We all get the benefits of living in an on-demand world. We can have groceries delivered to our door, deposit checks from the comfort of our pajamas, and watch thousands of television channels whenever and wherever we choose. My granddaughter hasn’t learned to tie her shoes, but at age four she can navigate an iPad as well as I can, and she already knows that Google can answer any question she has on a moment’s notice! This is also the era of possibility, where a start-up like WhatsApp, with only 50 or so employees, can disrupt an industry and sell for $19 billion!

Without a doubt, our lives are shaped by the seasons and events through which we live, but more importantly, it’s the meaning we give those events that will determine our ultimate trajectory.

THE 1970S

Ray Dalio, now 65, came of age in the 1970s. It was a time of violent change in seasons and arguably the worst economic environment since the Great Depression. High unemployment was accompanied by massive inflation, causing interest rates to skyrocket into the high teens. Remember I shared with you that my first mortgage coming out of the inflation of the 1970s was a whopping 18% interest! There was also an “oil shock” in 1973, as an embargo caught the United States off guard, causing oil prices to rise from $2.10 a barrel to $10.40. No one was prepared for this. Just a few years later, the government imposed odd-even rationing, where people were forced not only to wait in line at the pump for hours but also were allowed to gas up only on odd or even days of the month! It was a season of political strife as faith in our government dwindled after Vietnam and Watergate. In 1974 President Nixon was forced to resign and was later pardoned by his successor, former vice president Gerald Ford, for any wrongdoing (wink, wink).

In 1971 Ray Dalio was fresh out of college and a clerk on the New York Stock Exchange. He saw bull and bear markets come in short bursts and create massive volatility in different asset classes. Tides changed quickly and unexpectedly. Ray saw the huge opportunity but was equally or even more aware of the enormous risks that came with the territory. As a result, he became ferociously committed to understanding how all these scenarios and movements were intertwined. By understanding how the bigger economic “machine” worked, he would ultimately figure out how to avoid those cataclysmic losses that doom so many investors.

All of these events shaped young Ray Dalio to ultimately become the world’s largest hedge fund manager. But the seminal moment that most shaped Ray’s investment philosophy happened on a hot night in August 1971, when a surprise address from President Nixon would change the financial world as we know it.

A NIXON NIGHT

All three major networks had their broadcasting interrupted unexpectedly as the president of the United States suddenly appeared in living rooms across America. In a serious and agitated state, he declared, “I directed Secretary [John] Connally to suspend temporarily the convertibility of the dollar to gold.” In one brief sentence, just 14 words, President Nixon announced to the world that the dollar as we knew it would never be the same again. No longer would the dollar’s value be tied directly to gold. Remember Fort Knox? It used to be that for every paper dollar, the government would have the equivalent value of physical gold stocked away safely. And with Nixon’s declaration, the dollar was now just paper. Imagine you had a treasure chest filled with gold, only to open it one day and find a yellow paper sticky note that said simply “IOU.” Nixon was saying that the dollar’s value would now be determined by whatever we (the market) deemed its worth. This news also shocked foreign governments that had held huge sums of dollars, believing that they had the option to convert to gold at any time. Overnight, Nixon removed that option from the table (once again living up to his nickname “Tricky Dick”). Oh, he also issued a 10% surcharge on all imports to keep the United States competitive. And like a blizzard in late October, Nixon’s address signified a change in seasons of epic proportions.

Ray was watching the president’s address from his apartment and couldn’t believe what he was hearing. What were the implications of Nixon’s decision to take the United States off the gold standard? What did it mean for markets? What did this mean for the US dollar and its position in the world?

One thing Ray thought for sure: “It means the definition of money is different. I would have thought maybe it’s a crisis!” He was certain that when he walked onto the trading floor the next morning, the market was sure to plummet.

He was wrong.

To his amazement, the Dow Jones was up nearly 4% that next day, as stocks soared to the highest single-day gain in history. Gold also skyrocketed as well! It was completely counterintuitive to what most experts would expect. After all, we had just broken our sacred promise to the world that these pieces of paper with dead presidents on them were actually worth something of value. Surely this change wouldn’t inspire confidence in the US economy or government. This was a head scratcher. This market boom eventually became known as the “Nixon rally.” But it wasn’t all great news. By letting the value of the dollar be determined by “whatever we all think it’s worth,” an inflationary storm brewed on the horizon. Ray elaborates: “But then in 1973, it set up the ingredients for the first oil shock. We never had an oil shock before. We never had inflation to worry about before. And all of those things became, in a sense, surprises. And I developed a modus operandi to expect surprises.” It’s the surprises that we can’t afford, or stomach. It’s the next 2008. It’s the next shock wave sure to rumble through our markets.

The Nixon rally was a catalyst for Ray: the beginning of a lifelong obsession to prepare for anything—the unknown around every corner. His mission was to study every conceivable market environment and what that meant for certain investments. This is his core operating principle that allows him to manage the world’s largest hedge fund. Not espousing that he knows all. Quite the opposite. He is insatiably hungry to continually discover what he doesn’t yet know. Because what’s obvious is obviously wrong. The prevailing thought is usually the wrong thought. And since the world is continually changing and evolving, Ray’s journey to uncover the unknown is a never-ending endeavor.

ULTIMATE INVESTOR NIRVANA

What you are about to read could very well be the most important chapter in the entire book. Yes, yes, I know, I said that before. And it’s true that if you don’t know the rules of the game, you will get crushed. And if you don’t think like an insider, conventional wisdom will lead you to accept the fate of the herd. And if you don’t decide on a percentage and automate your savings, you will never get the rocket off the ground. Yet I wholeheartedly believe that there is nothing in this book that tops Ray’s strategy for the largest returns possible with the least amount of risk. This is Ray’s specialty. This is what Ray is known for throughout the world.

The portfolio you are going to learn about in the pages ahead would have provided you with:

1. Extraordinary returns—nearly 10% annually (9.88% to be exact, net of fees) for the last 40 years (1974 through 2013)!

2. Extraordinary safety—you would have made money exactly 85% of the time over the last 40 years! There were only six losses during those 40 years, and the average loss was only 1.47%. Two of the six losses were breakeven, for all intents and purposes, as they were 0.03% or less. So from a practical perspective, you would have lost money four times in 40 years.

3. Extraordinary low volatility—the worst loss you would have experienced during those 40 years was only –3.93%!

Remember Warren Buffett’s ultimate laws of investing? Rule 1: don’t lose money. Rule 2: see rule 1. The application of this rule is Ray’s greatest genius. This is why he is the Leonardo da Vinci of investing.

Anybody can show you a portfolio (in hindsight) where you could have taken gigantic risks and received big rewards. And if you didn’t fold like a paper bag when the portfolio was down 50% or 60%, you would have ended up with big returns. This advice is good marketing, but it’s not reality for most people.

I couldn’t fathom that there was a way for the individual investor (like you and me) to have stock market–like gains, yet simultaneously have a strategy that would greatly limit both the frequency and size of the losses in nearly every conceivable economic environment. Can you imagine a portfolio model that declined just 3.93% in 2008, when the world was melting down and the market was down 50% from its peak? A portfolio where you can more than likely be safe and secure when the next gut-wrenching crash wipes out trillions in America’s 401(k) accounts? This is the gift that lies in the pages ahead. (Note that past performance does not guarantee future results. Instead, I am providing you the historical data here to discuss and illustrate the underlying principles.) But before we dive in, and before you can appreciate the beauty and power of Ray’s guidance, let’s understand the backstory of one of the most incredible investors and asset allocators to walk the planet. Let’s learn why governments and the world’s largest corporations have Ray on speed dial so they can maximize their returns and limit their losses.

I’M LOVIN’ IT

Nineteen eighty-three was a bad year for chickens. It was the year that McDonald’s decided to launch the wildly successful “Chicken McNugget.” They were such a hit that it took a few years to work out supply-chain issues because they couldn’t get their hands on enough birds. But if it wasn’t for the genius of Ray Dalio, the Chicken McNugget wouldn’t even exist.

How does the world of high finance intersect with the fast-food-selling clown? Because when McDonald’s wanted to launch the new food, it was nervous about the rising cost of chicken and having to up its prices—not an option for its budget-conscious clientele. But the suppliers weren’t willing to give a fixed price for its chickens because they knew that it wasn’t the chickens that are expensive. It’s the cost of feeding them all that corn and soymeal. And if the feed costs rose, the suppliers would have to eat the losses.

McDonald’s called Ray, knowing that he is one of the world’s most gifted minds when it comes to eliminating or minimizing risk while maximizing upside—and he rang up a solution. He put together a custom futures contract (translation: a guarantee against future rising prices of corn and soymeal) that allowed suppliers to be comfortable selling their chickens for a fixed price. Bon appétit!

Ray’s expertise extends far beyond the boardrooms of major corporations. Just how far does his wisdom reverberate throughout the world? In 1997, when the US Treasury decided to issue inflation-protected bonds (today, they are commonly known as TIPS), officials came to Ray’s firm, Bridgewater, to seek advice on how to structure them. Bridgewater’s recommendations led to the current design of TIPS.

Ray is more than just a money manager. He is a master of markets and risk. He knows how to put together the pieces to tilt the odds of winning drastically in favor of him and his clients.

So how does Ray do it? What’s his secret? Let’s sit at the feet of this economic master and let him take us on a journey!

INTELLECTUAL NAVY SEALS

Remember the jungle metaphor Ray gave us way back in chapter 1? As Ray sees it, to get what we really want in life, we have to go through the jungle to get to the other side. The jungle is dangerous because of the unknowns. It’s the challenges lurking around the next bend that can hurt you. So, in order to get to where you want to go, you have to surround yourself with the smartest minds that you also respect. Ray’s firm, Bridgewater, is his personal team of “jungle masters.” He has more than 1,500 employees who are almost as obsessed as Ray with figuring out how to maximize returns and minimize risk.

As I mentioned early on, Bridgewater is the world’s largest hedge fund, with nearly $160 billion under its watch. This amount is astonishing, considering most “big” hedge funds these days hover around $15 billion. Although the average investor has never heard of Ray, his name echoes in the halls of the highest places. His observations, a daily report, are read by the most powerful figures in finance, from the heads of central banks to those in foreign governments, and even the president of the United States.

There is a reason why the world’s biggest players, from the largest pension funds to the sovereign wealth funds of foreign countries, invest with Ray. And here is a clue: it’s not “conventional wisdom.” He thinks way outside the box. Heck, he shatters the box. And his voracious appetite to continually learn and challenge the conventional and find “the truth” is what propelled Ray from his first office (his apartment) to a sprawling campus in Connecticut. His jungle team at Bridgewater has been called a group of intellectual Navy SEALS. Why? Because by working at Bridgewater, you are going through the jungle with Ray, arm in arm. The culture requires you to be creative, insightful, and courageous—always able to defend your position or views. But Ray also requires that you have the willingness to question or even attack anything you consider faulty. The mission is to find out what is true and then figure out the best way to deal with it. This approach requires “radical openness, radical truth, and radical transparency.” The survival (and success) of the entire firm depends on it.

ALPHA DOG

Ray Dalio put himself on the map with the extraordinary (and continual) success of his Pure Alpha strategy. Launched in 1991, the strategy now has $80 billion and has produced a mind-boggling 21% annualized return (before fees were taken out), and with relatively low risk. The fund’s investors include the world’s wealthiest individuals, governments, and pension funds. It’s the 1% of the 1% of the 1%, and the “club” has been closed to new investors for many years. The Pure Alpha strategy is actively managed, meaning that Ray and his team are continuously looking for opportunistic investments. They want to get in at the right time and get out at the right time. They aren’t just riding the markets, which was evidenced by a 17% gain (before fees) in 2008 while many hedge fund managers were closing their doors or begging investors not to pull out. The investors in the Pure Alpha strategy want big rewards and are willing to take risks—albeit still limiting their risk as much as humanly possible.

CHILDREN AND CHARITY

With incredible success managing the Pure Alpha strategy, Ray has built up quite a sizeable personal nest egg. Back in the mid-‘90s, he began to think about his legacy and the funds he wanted to leave behind, but he wondered, “What type of portfolio would I use if I wasn’t around to actively manage the money any longer?” What type of portfolio would outlive his own decision making and continue to support his children and philanthropic efforts decades from now?

Ray knew that conventional wisdom and conventional portfolio management would leave him in the hands of a model that continually shows that it can’t survive when times get tough. So he began to explore whether or not he could put together a portfolio—an asset allocation—that would do well in any economic environment in the future. Whether it’s another brutal winter like 2008, a depression, a recession, or so on. Because nobody knows what will happen five years from now, let alone 20 or 30 years out.

The results?

A completely new way to look at asset allocation. A new set of rules. And only after the portfolio had been tested all the way back to 1925, and only after it produced stellar results for Ray’s personal family trust, in a variety of economic conditions, did he begin to offer it to a select group. So long as they had the minimum $100 million investment, of course. The new strategy, known as the All Weather strategy, made its public debut in 1996, just four years before a massive market correction put it to the test. It passed with flying colors.

QUESTIONS ARE THE ANSWER

We’ve all heard the maxim “Ask and you shall receive!” But if you ask better questions, you’ll get better answers! It’s the common denominator of all highly successful people. Bill Gates didn’t ask, “How do I build the best software in the world?” He asked, “How can I create the intelligence [the operating system] that will control all computers?” This distinction is one core reason why Microsoft became not just a successful software company but also the dominant force in computing—still controlling nearly 90% of the world’s personal computer market! However, Gates was slow to master the web because his focus was on what was inside the computer, but the “Google Boys,” Larry Page and Sergey Brin, asked, “How do we organize the entire world’s information and make it accessible and useful?” As a result, they focused on an even more powerful force in technology, life, and business. A higher-level question gave them a higher-level answer and the rewards that come with it. To get results, you can’t just ask the question once, you have to become obsessed with finding its greatest answer(s).

The average person asks questions such as “How do I get by?” or “Why is this happening to me?” Some even ask questions that disempower them, causing their minds to focus on and find roadblocks instead of solutions. Questions like “How come I can never lose weight?” or “Why can’t I ever hang on to my money?” only move them farther down the path of limitation.

I have been obsessed with the question of how do I make things better? How do I help people to significantly improve the quality of their lives now? This focus has driven me for 38 years to find or create strategies and tools that can make an immediate difference. What about you? What question(s) do you ask more than any other? What do you focus on most often? What’s your life’s obsession? Finding love? Making a difference? Learning? Earning? Pleasing everyone? Avoiding pain? Changing the world? Are you aware of what you focus on most; your primary question in life? Whatever it is, it will shape, mold, and direct your life. This book answers the question, “What do the most effective investors do to consistently succeed?” What are the decisions and actions of those who start with nothing but manage to create wealth and financial freedom for their families?

In the financial world, Ray Dalio became obsessed with a series of better-quality questions. Questions that led him to ultimately create the All Weather portfolio. It’s the approach you are about to learn here and has the potential to change your financial life for the better forever.

“What kind of investment portfolio would one need to have to be absolutely certain that it would perform well in good times and in bad—across all economic environments?” This might sound like an obvious question, and, in fact, many “experts” and financial advisors would say that the diversified asset allocation they are using is designed to do just that. But the conventional answer to this question is why so many professionals were down 30% to 50% in 2008. We saw how many target-date funds got slaughtered when they were supposed to be set up to be more conservative as their owners neared retirement age. We saw Lehman Brothers, a 158-year-old bedrock institution, collapse within days. It was a time when most financial advisors were hiding under their desks and dodging client phone calls. One friend of mine joked painfully, “My 401(k) is now a 201(k).” All the fancy software that the industry uses—the “Monte Carlo” simulations that calculate all sorts of potential scenarios in the future—didn’t predict or protect investors from the crash of 1987, the collapse of 2000, the destruction of 2008—the list goes on.

If you remember those days back in 2008, the standard answers were “This just hasn’t happened before,” “We are in uncharted waters,” “It’s different this time.” Ray doesn’t buy those answers (which is why he predicted the 2008 global financial crisis and made money in 2008).

Make no mistake, what Ray calls “surprises” will always look different from the time before. The Great Depression, the 1973 oil crisis, the rapid inflation of the late ’70s, the British sterling crisis of 1976, Black Monday in 1987, the dot-com bubble of 2000, the housing bust in 2008, the 28% drop in gold prices in 2013—all of these surprises caught most investments professionals way off guard. And the next surprise will have them on their heels again. That we can be sure of.

But in 2009, once the smoke had cleared and the market started to bounce back, very few money managers stopped to ask if their conventional approach to asset allocation and risk management might have been wrong to begin with. Many of them dusted themselves off, got back in the selling saddle, and prayed that things would just get back to “normal.” But remember Ray’s mantra, “Expect surprises,” and his core operating question, “What don’t I know?” It’s not a question of whether or not there will be another crash, it is a question of when.

MARKOWITZ: THE SECRET TO MAXIMIZING RETURNS

Harry Markowitz is known as the father of modern portfolio theory. He explains the fundamental concept behind the work that won him the Nobel Prize. In short, investments in a portfolio should not just be looked at individually, but rather as a group. There is a trade-off for risk and return, so don’t just listen to one instrument, listen to the entire orchestra. And how your investments perform together, how well they are diversified, will ultimately determine your reward. This advice might sound simple now, but in 1952 this thinking was groundbreaking. At some level, this understanding has influenced virtually every portfolio manager from New York to Hong Kong.

Like all great investors, Ray stood on Markowitz’s shoulders, using his core insights as a basis for thinking about the design of any portfolio or asset allocation. But he wanted to take it to another level. He was sure that he could add a couple more key distinctions—pull a couple key levers—and create his own groundbreaking discovery. He took his four decades of investing experience and rounded up his troops to focus their brainpower on this project. Ray literally spent years refining his research until he had arrived at a completely new way to look at asset allocation. The ultimate in maximizing returns and minimizing risk. And his discoveries have given him a new level of competitive advantage—an advantage that will soon become yours.

Up until this book’s publication, Ray’s life-altering, game-changing approach has been for the exclusive benefit of his clients. Governments, pension plans, billionaires—all get the extraordinary investment advantages you are about to learn—through Ray’s All Weather strategy. As I mentioned, it’s where Ray has serious skin in the game. It’s where he invests all of his family and legacy money alongside the “Security Buckets” of the most conservative and sophisticated institutions in the world. Like Ray, I also now invest a portion of my family’s money in this approach, as well as my foundation’s money, because as you’ll begin to see, it has produced results in every economic environment over the last 85 years. From depressions and recessions, to times of inflation or deflation; in good times and in bad, this strategy has found a way to maximize opportunity. Historically it appears to be one of the best approaches possible to achieving my wishes long after I am gone.

GAME DAY

To be able to sit with yet another of the great investment legends of our time was truly a gift. I spent close to 15 hours studying and preparing for my time with Ray, combing over every resource I could get my hands on (which was tough, because he typically avoids media and publicity). I dug up some rare speeches he gave to world leaders at Davos and the Council on Foreign Relations. I watched his interview with Charlie Rose of 60 Minutes (one of his only major media appearances). I watched his instructional animated video How the Economic Machine Works—In Thirty Minutes (www.economicprinciples.org). It’s a brilliant video I highly encourage you to watch to really understand how the world economy works. I combed through every white paper and article I could find. I read and highlighted virtually every page of his famous text Principles, which covers both his life and management guiding principles. This was an opportunity of a lifetime, and I wasn’t going to walk in without being completely prepared.

What was supposed to be a one-hour interview quickly turned into nearly three. Little did I know Ray was a fan of my work and had been listening to my audio programs for almost 20 years. What an honor! We went deep. We were pitching and catching on everything from investing to how the world economic machine really works. I began with a simple question: “Is the game still winnable for the individual investor?” “Yes!” he said emphatically. But you certainly aren’t going to do it listening to your broker buddy. And you certainly aren’t going to do it by trying to time the market. Timing the market is basically playing poker with the best players in the world who play round the clock with nearly unlimited resources. There are only so many poker chips on the table. “It’s a zero-sum game.” So to think you are going to take chips from guys like Ray is more than wishful thinking. It’s delusional. “There is a world game going on, and only a handful actually make money, and they make a lot by taking chips from the players who aren’t as good!” As the old saying goes, if you have been at a poker table for a while, and you still don’t know who the sucker is: it’s you!

Ray put the final warning stamp on trying to beat/time the market: “You don’t want to be in that game!”

“Okay, Ray, so we know we shouldn’t try to beat the best players in the world. So let me ask you what I have asked every person I have interviewed for this book: If you couldn’t leave any of your financial wealth to your children but only a portfolio, a specific asset allocation with a list of principles to guide them, what would it be?” Ray sat back, and I could see his hesitancy for a moment. Not because he didn’t want to share, but because we live in an incredibly complex world of risk and opportunity. “Tony, that’s just too complex. It’s very hard for me to convey to the average individual in a short amount of time, and things are constantly changing.” Fair enough. You can’t cram 47 years of experience into a three-hour interview. But I pressed him a bit . . .

“Yeah, I agree, Ray. But you also just told me how the individual investor is not going to succeed by using a traditional wealth manager. So help us understand what we can do to succeed. We all know that asset allocation is the most important part of our success, so what are some of the principles that you would use to create maximum reward with minimal risk?” And that’s when Ray began to open up and share some amazing secrets and insights. His first step was to shatter my “conventional wisdom” and show me that conventional wisdom on what is a “balanced” portfolio is not balanced at all.

The secret of all victory lies in the organization of the nonobvious.

—MARCUS AURELIUS

UNBALANCED

Most advisors (and advertisements) will encourage you to have a “balanced portfolio.” Balance sounds like a good thing, right? Balance tells us that we aren’t taking too much risk. And that our more risky investments are offset by our more conservative ones. But the question lingers: Why did most conventional balanced portfolios drop 25% to 40% when the bottom fell out of the market?

The conventional balanced portfolios are divided up between 50% stocks and 50% bonds (or maybe 60/40 if you are a bit more aggressive, or 70/30 if you are even more aggressive). But let’s stick with 50/50 for the sake of this example. That would mean if someone has $10,000, he would invest $5,000 in stocks and $5,000 in bonds (or similarly, $100,000 would mean $50,000 in bonds and $50,000 in stocks—you get the idea).

By using this typical balanced approach, we are hoping for three things:

1. We hope stocks will do well.

2. We hope bonds will do well.

3. We hope both don’t go down at the same time when the next crash comes.

It’s hard not to notice that hope is the foundation of this typical approach. But insiders like Ray Dalio don’t rely on hope. Hope is not a strategy when it comes to your family’s well-being.

RISKY BUSINESS

By dividing up your money in 50% stocks and 50% bonds (or some general variation thereof), many would think that they are diversified and spreading out their risk. But in reality, you really are taking much more risk than you think. Why? Because, as Ray pointed out emphatically multiple times during our conversation, stocks are three times more risky (aka volatile) than bonds.

“Tony, by having a fifty-fifty portfolio, you really have more like ninety-five percent of your risk in stocks!” Below is a pie chart of the 50/50 portfolio. The left side shows how the money is divided up between stocks and bonds in percentage terms. But the right side shows how the same portfolio is divided up in terms of risk.

So with 50% of your “money” in stocks, it seems relatively balanced at first glance. But as shown here, you would have closer to 95% or more at “risk” because of the size and volatility of your stock holdings. Thus, if stocks tank, the whole portfolio tanks. So much for balance!

How does this concept translate to real life?

From 1973 through 2013, the S&P 500 has lost money nine times, and the cumulative losses totaled 134%! During the same period, bonds (represented by the Barclays Aggregate Bond index) lost money just three times, and the cumulative losses were just 6%. So if you had a 50/50 portfolio, the S&P 500 accounted for over 95% of your losses!

“Tony,” Ray said, “when you look at most portfolios, they have a very strong bias to do well in good times and bad in bad times.” And thus your de facto strategy is simply hoping that stocks go up. This conventional approach to diversifying investments isn’t diversifying at all.

I had never heard this concept of balance versus risk explained so simply. As I sat there, I started to think back to my own investments and where I may have made some wrong assumptions.

So let me ask you, how does this understanding make you feel about your “balanced” portfolio now?

Does this change your view as to what it means to be diversified? I sure hope so! Most people try to protect themselves by diversifying the amount of money they put into certain investment assets. One might say, “Fifty percent of my money is in ‘risky’ stocks (with perhaps greater upside potential if things go well) and fifty percent of my money is going in ‘secure’ bonds to protect me.” Ray is showing us that if your money is divided equally, yet your investments are not equal in their risk, you are not balanced! You are really still putting most of your money at risk! You have to divide up your money based on how much risk/reward there is—not just in equal amounts of dollars in each type of investment.

You now know something that 99% of investors don’t know and that most professionals don’t know or implement! But don’t feel bad. Ray says most of the big institutions, with hundreds of billions of dollars, are making the same mistake!

RAINMAKER

Ray was now on a roll and was systematically dissecting everything I had been taught or sold over the years!

“Tony, there is another major problem with the balanced portfolio ‘theory.’ It’s based around a giant and, unfortunately, inaccurate assumption. It’s the difference between correlation and causation.” Correlation is a fancy investment word for when things move together. In primitive cultures, they would dance in an attempt to make it rain. Sometimes it actually worked! Or so they thought. They confused causation with correlation. In other words, they thought their jumping up and down caused the rain, but it was actually just coincidence. And if it happened more and more often, they would build some false confidence around their ability to predict the correlation between their dancing and the rain.

Investment professionals often buy into the same mythology. They say that certain investments are either correlated (move together) or uncorrelated (have no predictable relationship). And yes, at times they might be correlated, but like the rainmaker, it’s often just happenstance.

Ray and his team have shown that all historical data point to the fact that many investments have completely random correlations. The 2008 economic collapse destroyed this glaring assumption when almost all asset classes plummeted in unison. The truth is, sometimes they move together, sometimes they don’t. So when the professionals try to create balance, hoping stocks move in the opposite direction of bonds, for example, it’s a complete crapshoot. But this faulty logic is the underpinning of what most financial professionals use as their “true north.” Ray has clearly uncovered some glaring holes in the traditional asset allocation model. If he were a professor at an Ivy League school and had published this work, he probably would have been nominated for a Nobel Prize! But in the trenches—in the jungle—is where Ray would rather live.

THE FOUR SEASONS

When I talked with David Swensen, Yale’s chief investment officer, he told me that “unconventional wisdom is the only way you can succeed.” Follow the herd, and you don’t have a chance. Oftentimes people hear the same advice or thinking over and over again and mistake it for the truth. But it’s unconventional wisdom that usually leads to the truth and more often leads to a competitive advantage.

And here is where Ray’s second piece of unconventional wisdom came crashing in. “Tony, when looking back through history, there is one thing we can see with absolute certainty: every investment has an ideal environment in which it flourishes. In other words, there’s a season for everything.” Take real estate, for example. Look back to the early 2000s, when Americans were buying whatever they could get their hands on (including people with little money!). But they weren’t just buying homes because “interest rates were low.” Interest rates were even lower in 2009, and they couldn’t give houses away. People were buying during the boom because prices were inflating rapidly. Home prices were rising every single month, and they didn’t want to miss out. Billionaire investing icon George Soros pointed out that “Americans have added more household mortgage debt in the last six years [by 2007] than in the prior life of the mortgage market.” That’s right, more loans were issued in six years than in the entire history of home loans.

In Miami and many parts of South Florida, you could put down a deposit, and because of inflationary prices, before the condo was even finished being built, you could sell it for a sizeable profit. And what did people do with that home equity? They used their home like an ATM and spent it, and that massive spending stimulated the profitability of corporations and the growth of the economy. Soros cited some staggering numbers: “Martin Feldstein, a former chairman of the Council of Economic Advisers, estimated that from 1997 through 2006, consumers drew more than $9 trillion in cash out of their home equity.” To put this in perspective, in just six years (from 2001 to 2007), Americans added more household mortgage debt (about $5.5 trillion) than in the prior life of the mortgage market, which is more than a century old. Of course, this national behavior is not a sustainable way to live. When home prices dropped like a rock, so did spending and the economy.

In summary, which season or environment can powerfully drive home prices? Inflation. But in 2009 we experienced deflation, when prices sank, and many mortage holders were left with a home underwater—worth less than what they owed. Deflation drops the price of this investment class.

How about stocks? They too perform well during inflation. With inflation comes rising prices. Higher prices mean that companies have the opportunity to make more money. And rising revenues mean growth in stock prices. This has proven true over time.

Bonds are a different animal. Take US Treasury bonds, for example. If we have a season of deflation, which is accompanied by falling interest rates, bond prices will rise.

Ray then revealed the most simple and important distinction of all. There are only four things that move the price of assets:

1. inflation,

2. deflation,

3. rising economic growth, and

4. declining economic growth.

Ray’s view boils it down to only four different possible environments, or economic seasons, that will ultimately affect whether investments (asset prices) go up or down. (Except unlike nature, there is not a predetermined order in which the seasons will arrive.) They are: 1. higher than expected inflation (rising prices),

1. lower than expected inflation (or deflation),

2. higher than expected economic growth, and

3. lower than expected economic growth.

When you look at a stock (or bond) price today, the price already incorporates what we (the market) “expect” about the future. Ray said to me, “Tony, there is a literal picture of the future when you look at prices today.” In other words, the price of Apple’s stock today incorporates the expectations of investors who believe the company will continue to grow at a certain pace. This is why you may have heard that a stock will fall when a company says that its future growth (earnings) will be lower than it had initially expected.

“It’s the surprises that will ultimately determine which asset class will do well. If we have a real good growth surprise, that would be very good for stocks and not great for bonds. For bonds, if we have a surprise drop in inflation, it would be good for bonds.” If there are only four potential economic environments or seasons, Ray says you should have 25% of your risk in each of these four categories. He explains: “I know that there are good and bad environments for all asset classes. And I know that in one’s lifetime, there will be a ruinous environment for one of those asset classes. That’s been true throughout history.” This is why he calls this approach All Weather: because there are four possible seasons in the financial world, and nobody really knows which season will come next. With this approach, each season, each quadrant, is covered all the time, so you’re always protected. Ray elaborates: “I imagine four portfolios, each with an equal amount of risk in them. That means I would not have an exposure to any particular environment.” How cool is that? We aren’t trying to predict the future, because nobody knows what the future holds. What we do know is that there only four potential seasons we will all face. By using this investment strategy, we can know that we are protected—not merely hoping—and that our investments are sheltered and will do well in any season that comes our way.

Bob Prince, the co-chief investment officer at Bridgewater, describes the uniqueness of the All Weather approach: “Today we can structure a portfolio that will do well in 2022, even though we can’t possibly know what the world will look like in 2022.” I honestly sat there with my jaw open because nobody had ever described to me such a simple yet elegant solution. It makes perfect sense to have investments, divided up equally by risk, that will do well in all seasons but how you actually accomplish this is the golden ticket.

“So we know the four potential seasons, but which type of investment will perform well in each of these environments?” Ray responded by categorizing them into each season. Below is a chart that makes it easy to break down visually.

TWO DOWN, ONE TO GO

On the surface, asset allocation might sometimes feel complex, even when you understand the principles that Ray has laid out. But there’s one thing I know for sure: complexity is the enemy of execution. If you and I are actually going to get ourselves to follow through with this process and receive the rewards, I had to find a way to make this advice even simpler.

So I said to Ray, “What you have shared with us here is invaluable. A completely different way of looking at asset allocation. By now we all know asset allocation is one of the single most important keys to all successful investing. But the challenge for the average investor—and even for the sophisticated investor—is how to take these principles and translate them into an actual portfolio with the most effective percentages of each asset class. It will be too complex for ninety-nine percent of us to figure out. So it would be a huge gift if you could share the specific percentages that people would invest in each asset class so that their risk would be divided equally among seasons!” Ray looked at me, and I could see the wheels turning. “Tony, it’s not really that simple.” Ray explained that in his All Weather strategy, they use very sophisticated investment instruments, and they also use leverage to maximize returns.

I understood where Ray was coming from, so I asked him for a more simplified version: “Can you give me the percentages that the average person can do, without any leverage, to get the best returns with the least amount of risk? I know it’s not going to be your absolute perfect asset allocation because I’m putting you on the spot to create it right here and now. But Ray, your best estimate will certainly be greater than most people’s best plan. Could you give a version of the All Weather portfolio that readers could do on their own or with the help of a fiduciary advisor?” Ray has taken on very few investors in the last ten years, and the last time he did, you had to be an institutional investor with $5 billion in investable assets, and your initial investment needed to be a minimum of $100 million just to get Ray’s advice. This helps you understand what a big ask I was making. But I know how much he cares about the little guy. He certainly hasn’t forgotten his roots as a self-made man from humble beginnings in Queens, New York.

“Ray, I know you’ve got a huge heart to help, so let’s give folks a recipe for success. You won’t take anybody’s money, even if they are worth five billion dollars today. Help your brothers and sisters out!” I said with a big smile.

And then something magical happened.

I looked in Ray’s eyes, and a smile came across his face. “All right, Tony. It wouldn’t be exact or perfect, but let me give you a sample portfolio that the average person could implement.” And then slowly he began to unfold the exact sequence for what his experience shows will give you and me the increased probability of the highest return in any market environment, as long as we live, with the least amount of risk.

DRUMROLL, PLEASE

You are about to see the exact asset allocation built by a man whom many call the best asset allocator to walk the planet. A self-made man who built himself from nothing financially to a net worth of over $14 billion, and who manages $160 billion a year and produces annual returns of more than 21% for his investors (before fees). Here he shares not only which type of investment but also what percentage of each asset class you need to win! In fact, if you look online, many people have tried to replicate a version of this based upon Ray’s previous interviews. In fact, there is a whole new category of investment products now called “Risk Parity,” based on Ray’s innovations. Many funds or strategies say they were “inspired” by Ray’s approach, but nobody received the specific allocation like Ray provided here. Many of the replicas were down as much as 30% or more in 2008. More like “some weather” than “All Weather,” if you ask me. A fake Rolex will never be a Rolex. (A quick note: the strategy below is not the same as Ray’s All Weather strategy, of course. As he said, his fund uses more sophisticated investments and also uses leverage. But the core principles are the same, and the specific percentages are designed directly by Ray, and no one else, so let’s call this portfolio herein the “All Seasons” portfolio.) GIVE ME THE NUMBERS

“So tell me, Ray, what are the percentages you would put in stocks? What percentage in gold? And so on.” He graciously proceeded to sketch out the following breakdown: First, he said, we need 30% in stocks (for instance, the S&P 500 or other indexes for further diversification in this basket). Initially that sounded low to me, but remember, stocks are three times more risky than bonds. And who am I to second-guess the Yoda of asset allocation!?

“Then you need long-term government bonds. Fifteen percent in intermediate term [seven- to ten-year Treasuries] and forty percent in long-term bonds [20- to 25-year Treasuries].” “Why such a large percentage?” I asked.

“Because this counters the volatility of the stocks.” I remembered quickly it’s about balancing risk, not the dollar amounts. And by going out to longer-term (duration) bonds, this allocation will bring a potential for higher returns.

He rounded out the portfolio with 7.5% in gold and 7.5% in commodities. “You need to have a piece of that portfolio that will do well with accelerated inflation, so you would want a percentage in gold and commodities. These have high volatility. Because there are environments where rapid inflation can hurt both stocks and bonds.” Lastly, the portfolio must be rebalanced. Meaning, when one segment does well, you must sell a portion and reallocate back to the original allocation. This should be done at least annually, and, if done properly, it can actually increase the tax efficiency. This is part of the reason why I recommend having a fiduciary implement and manage this crucial, ongoing process.

GRATITUDE

Wow! There it was in black and white. Ray had masterfully and graciously provided a game-changing recipe that would impact the lives of millions of Americans. Do you realize the level of generosity this man provided both you and me that wonderful day? Giving from the heart is at the core of who Ray is. Which is why I wasn’t the least bit surprised to learn later that he and his wife, Barbara, have signed the Giving Pledge—a commitment by the world’s wealthiest individuals, from Bill Gates to Warren Buffett, to give away the majority of their wealth through philanthropy.

DO I HAVE YOUR ATTENTION NOW?

When my own investment team showed me the back-tested performance numbers of this All Seasons portfolio, I was astonished. I will never forget it. I was sitting with my wife at dinner and received a text message from my personal advisor, Ajay Gupta, that read, “Did you see the email with the back-tested numbers on the portfolio that Ray Dalio shared with you? Unbelievable!” Ajay normally doesn’t text me at night, so I knew he couldn’t wait to share. As soon as our dinner date was over I grabbed my phone and opened the email . . .