To help us understand how he got to his principles, Ray Dalio shares a history of his founding of his hedge fund Bridgewater Associates. He cautions that his particular story can distract from the merit of his principles, which are timeless and universal. So he advises you to skip his biography if you’d rather judge his principles on their own merit.
To be a successful financial trader, you need to be an independent thinker. You need to 1) bet against the consensus view, and 2) be right. Aiming for this means that you’ll be wrong a lot. By making a lot of mistakes, Dalio developed a fear of being wrong, and he tried to figure out how to approach decision making to maximize his chance of being right.
This shifted his perspective from stating, “I know I’m right” to asking the questions, “How do I know I’m right? What am I missing?” Asking these questions prompted him to be relentlessly curious about why other smart people disagreed with him. He learned to get a broad range of inputs from other people, then weigh them according to how credible they were. This increased his chances of being right.
Importantly, Dalio had gone through so many mistakes and went through such painful times, that he learned not to care about whether the right answer came from him. He just wanted to be right.
Dalio found he succeeded best when he systematized his decision-making process into algorithms so clear that even computers could run them. This had a number of benefits:
In financial trading, he was able to visualize the market as a machine, made up of individual cause-effect relationships. For example, the price of pork bellies depended on what cuts of meat consumers prefer to eat, how much grain pigs eat, and how rain affects crop yield for grains. To Dalio, this looked like a “beautiful machine” that he could model and predict prices of.
Dalio learned that articulating clear principles helped other people see his logic and process of decision making.
Furthermore, he shares his principles with his team and invites them to test the principles. He therefore gets a chance to refine his principles and make even better decisions.
Dalio emphasizes that money was just an incidental product of good work. To him, meaningful work and meaningful relationships were his primary goals, and were far more valuable than money.
Ray Dalio grew up in Long Island as an only child. His father was a jazz musician and his mother was a stay-at-home mom.
He describes his early character traits:
As a result, he didn’t like school, since what his teachers were teaching never seemed all that important.
But when he did develop an interest in something, he was unstoppable. He eagerly worked for money starting at age eight, delivering newspapers, shoveling snow, caddying at a golf club, and working in a restaurant. He found that independently handling money taught him far more useful lessons than school did.
In the 1960s when he grew up, the United States was on a tear. Everything seemed to be improving, and ambitious goals like space travel rallied the nation.
Importantly for Dalio’s life trajectory, the stock market was doing great, quadrupling over the previous ten years. After hearing people talk about buying stocks at the golf course he was caddying at, Dalio bought shares of Northeast Airlines because it was the only company he found that sold for less than $5 a share. He bought as many shares as he could, figuring that more shares would earn him more money. In retrospect, this was a dumb strategy, but he got lucky—he tripled his money. He thought making money investing was easy, and he got hooked on the stock market.
He started getting as many annual reports from public companies as he could and digging into them. Like many others, he tried to pick the best stocks to get the best returns.
1966 would be the stock market’s top. He would soon learn a lot of lessons about financial markets.
Dalio had a C average in high school and attended a local college, C.W. Post. But he enjoyed college since he could study things that he was actually interested in. He majored in finance and graduated in 1971 with nearly perfect grades, which got him into Harvard Business School.
During this time, the United States faced social turmoil with the Vietnam War, and economic turmoil with a declining stock market and currency fluctuations. By watching the news and the market, Dalio began sensing a bigger picture and the cause-effect relationships that determine how the market moves.
For example, the summer after Dalio graduated from college, President Nixon announced that the US dollar would no longer be convertible into gold, which caused the dollar to plummet. But the next day, the stock market jumped by 4%. Dalio was confused. He spent the rest of the summer studying currency devaluations and found that this pattern had occurred in history—just not in his lifetime. There was a predictable string of cause-effect relationships that made this outcome very predictable.
As another example, in 1973, the US economy slowed, the stock market sank, and commodity prices shot up. While this was confusing at the time, in retrospect, there was a logical sequence of events:
Even though a modern event might seem novel, it has likely happened in the past, as a result of logical cause-effect relationships. Dalio committed to studying history broadly so he could become aware of more situations and how to deal with them, even if he had personally never seen them before. His goal became to be able to identify what situation he was in, to understand the relationships behind them, then to predict what would happen in the future.
While at Harvard Business School, Dalio took an interest in trading commodities. Unlike stocks, which could stay high or low because of public perception and trading with a “greater fool,” commodities like meat and grain represented real things that people would pay for at a grocery counter. This allowed Dalio to model the cause-effect relationships in the whole system, from how rain affects crop yield, to how much grain livestock eat, to what cuts of meat consumers prefer to eat. To Dalio, this looked like a “beautiful machine” that he could model and predict prices of.
After graduating with his MBA, Dalio worked as a commodities trader in a brokerage firm while also trading his own account. Today, he remembers his trading mistakes far more vividly than his wins. At one point, he had a big loss on pork bellies, which plummeted in value for a few days. He would hear the commodity price ticker click and clack, announcing he’d just lost another sum of money. This visceral experience taught him a healthy fear of being wrong, and the caution to cap his losses to avoid being taken out of the game.
Dalio was fired from his brokerage firm for being too wild (he shares that he once punched his boss in the face). But his old clients still wanted his advice, so in 1975 he started Bridgewater Associates.
Bridgewater’s service began by advising customers on how to handle market risks.
Eventually, Bridgewater also began to buy and sell on his clients’ behalf, earning a percentage of profits. Dalio’s ability to visualize the market as a complex machine gave him a competitive advantage over other firms who didn’t.
The late 1970s were one of the most volatile periods in markets in history. The fluctuations were caused by big shocks like breaking the link between the dollar to gold in 1971, the oil crisis after the Iranian Revolution, and the Fed’s monetary policy to try to control inflation.
During all of this, Dalio confidently predicted that the next depression was soon to come. He saw that debt levels were at record highs and rising faster than borrowers could repay them, particularly to emerging countries. The Fed was in a difficult position. It could print more money to avoid a cash crunch, but this would stimulate more inflation. On the other hand, if the Fed were to control inflation by becoming tight, this would trigger a massive decline in markets.
Dalio had seen elements of this before. He’d studied the past two centuries of economic history for debt and depressions. He was confident that a depression was coming, and he told his clients at Bridgewater this. To profit from his prediction, he held gold (which performs well in inflation) and bonds (which perform well in depressions).
At first, it looked like Dalio was completely right. In August 1982, Mexico defaulted on its debt, and it seemed clear that other emerging countries would follow. The Fed’s policies hadn’t been enough. Dalio’s bond bets were beginning to pay off.
Dalio looked clairvoyant for his predictions. He testified at Congressional hearings on the crisis, and he went on finance shows, claiming “I can say that with absolute certainty, because I know how markets work.” The Fed tried to ease the situation by making money more available, but Dalio predicted credit problems would only get worse, seeing analogies to the Great Depression in 1929.
He was completely wrong. The market rebounded in response to the Fed’s actions. Inflation fell, and growth accelerated. Over the next two decades, the economy enjoyed the greatest growth period in history.
Dalio lost nearly everything. He had to let go of his entire staff, leaving only himself. He had to sell their second car and borrow money from his father. After eight years building Bridgewater, he had to start from zero once again.
What did Dalio learn from this incredibly painful experience?
First, despite losing nearly everything, he knew that he wanted to continue working for himself. He didn’t want to get a job. And if he was going to succeed in going after what he wanted, he needed to reflect on the failure and change for the better.
Reviewing his actions, he found a few critical mistakes.
In retrospect, this failure was one of the best things that happened to Dalio, because it revolutionized his approach to personal improvement and decision-making, and it led to a golden era for Bridgewater.