After you collect information, how do you make the best decisions for yourself? While each decision has unique particularities, Dalio describes general principles to take into any decision.
There are really only two steps to making a decision: 1) learning, and 2) deciding.
The foundation of decision-making is gathering the best information possible. To do so, you need to be radically open-minded and have thoughtful disagreements with people (both of these ideas are discussed in previous chapters).
To make sense of all the information you receive, you need to use each piece of information appropriately.
Synthesize a good understanding of the situation that you’re making a decision for. This often means understanding the current performance level, as well as how that level has changed over time.
Focus on a “by and large” general level of understanding. Don’t get obsessed about details that don’t really matter. Don’t focus on edge cases or whether something is “totally true.”
Understand the situation at multiple levels of detail. There is a top level of the most important points, as well as lower levels of supporting detail. Whenever you make a decision, you should be clear what level of detail you’re on.
For example, here are levels of detail for someone who’s deciding about a career:
The lower levels of detail support the higher levels and form a complete logical picture. It’s important to see these different levels, rather than seeing all the points as a random pile of facts with no greater logic.
If this sounds like a foreign concept, realize that you navigate between different levels all the time without consciously realizing it.
To get better at navigating between levels, consciously think about what level you’re at in daily life. For example, if you’re in a conversation, make clear with the person you’re talking to whether you’re talking about main points or sub-points. It’s common for conversations to get derailed when they plunge deep into the weeds in details, without surfacing back up to the main points.
Once you’ve gathered your information, you can make a decision. Here are principles for making good decisions of any kind.
What hurts good decision-making the most is emotions. To avoid having your emotions bias your decisions, figure out the criteria underlying your decision-making, then automate the decision as much as you can.
We’ve learned that principles are the core of how you behave. Principles are fundamental truths that allow you to make better decisions quickly. When you recognize a situation as “another one of those,” you can just refer to your rules as a shortcut to good decision-making.
Ideally, you can convert your principles into algorithms and have the computer decide alongside you. Here’s how:
(Shortform note: If it’s unclear what algorithms are, think of an “if-then” statement. For example, “If I receive enough money to pay my bills, I will save 20% of what remains in my retirement account. If I don’t, I will pay my highest interest bills first, then try to cut down my spending.” Having clear rules like this gives you an easy way to make decisions without thinking hard, from scratch, each time.)
Here are a few examples of how Dalio and Bridgewater automate decision-making:
Remember that good principles are timeless and universal. Have respect for history—what you see as a situation now may not have happened before in your lifetime.
Between people, the principles are the true basis for disagreements. Rather than argue about the conclusions both of you have, argue about the principles that each of you used to arrive at your conclusions. If both of you agree on the principles, then you should also agree on the decision.
Sometimes it appears you’re between a rock and a hard place. You only have a choice between two difficult options, or they each trade off something that is unnegotiable.
In these situations, instead of taking either difficult option, look harder for a novel solution that you haven’t found yet. You might be able to create a better solution that lets you have your cake and eat it too.
Here are examples of how Dalio was able to find an optimal solution where none was obvious.
In investing, it seemed Bridgewater could take one of two paths: high-risk high-return, or low-risk low-return. The former was so volatile it risked a total wipeout; the latter is unrewarding.
Instead, upon thinking harder, Dalio found his “holy grail” of investing—compiling a portfolio of uncorrelated assets could improve the return-to-risk ratio and reduce the risk of losing money in any given year. He could essentially have high-returns with lower risk.
This led to Bridgewater’s flagship fund, Pure Alpha, which has returned an annual average of 18% across its nearly 30 years and is considered the best performing fund of all time.
In the 90s, Dalio’s lieutenants gave him feedback about how his openness makes them feel incompetent and humiliated and engenders toxicity. It seemed they could have one of two things: 1) be radically truthful and bring weaknesses to the surface, 2) have happy and satisfied employees.
He came to understand that people who weren’t as close to Ray didn’t know his principles and misinterpreted his directness.
This led Ray to put his management principles in writing, clarifying why radical transparency was critical to success, and providing a framework for resolving disagreements.
Every action has a direct “first-order” consequence, as well as longer-term second- and third-order consequences.
For example, saving money has the first-order consequence of deducting money from your account that you can’t spend today. While this is painful, the second-order effect is better—you have more money saved for retirement. The third-order effect is even better still—with more money saved for retirement, you feel less stress about your career and might have more options for how you spend your time.
Think of the consequences as a series of dominoes, one triggering the other.
Some of the hardest habits to adopt have painful short-term first-order consequences but fantastic second- and third-order consequences. Don’t let short-term first-order consequences deter you from reaching the real goals.
As another example, physical fitness requires the painful first-order consequence of exercise, dieting, and self-restraint when eating. The second-order consequence is better health. The third-order consequence is greater happiness, self-confidence, and more. It’s worth enduring the shorter-term pain for the longer-term gain.
Inversely, some things that are bad for you long-term have very tempting first-order consequences. For example, smoking presents an immediate first-order reward, with dire long-term consequences.
From his evolutionary viewpoint, Dalio considers that nature may even be throwing us trick choices to punish people who make short-term decisions on first-order consequences alone.
When you have your options on the table, assess them for what gives you the highest expected value.
The concept of expected value comes from statistics and involves multiplying the probability of an outcome by its value. For example, say an opportunity has a 20% chance of returning $1,000, or an 80% chance of failing and costing you $100. The expected value is 20% times $1,000 plus 80% times -$100, or $200 - $80, or $120. Here, the expected value is positive, so it’s probably a good bet, even though you have a majority chance of losing money.
Dalio’s point here is to avoid rejecting an option simply because there’s something wrong with it. Many people shy away from options that have any possibility of downside, taking very safe options instead, even though the safe options don’t have the highest expected value.
Every option has a probability and reward for being right, and a probability and penalty for being wrong. The important thing is to figure out what those probabilities are, then choose the one that will give you the best return.
Here are a few important conclusions from this style of thinking: