Transcripts > The Tim Ferriss Show > #264: Ray Dalio, The Steve Jobs of Investing
Hello my little munchkins, boys, and girl, this is Tim Ferriss, and welcome to another episode of the Tim Ferriss Show, where it is always my job to deconstruct world class performers to share the thinking, the habits, the tips and tricks that you can apply in your own life, whether those people come from the worlds of sports, from chess, from entertainment, and in this case, from investing.
I’m very, very excited about this conversation you are about to hear. I had a blast. It is with Ray Dalio, who has been called “The Steve Jobs of Investing.” We’ll get to why that is the case. This is Ray’s first long form podcast ever, which I’m extremely happy to debut here. On Twitter @raydalio. You can say hello.
Grew up a middle class kid from Long Island. He started his investment company, Bridgewater Associates, out of a two bedroom apartment at age 26. Now has roughly $160 billion in assets under management. Over 42 years, he built Bridgewater into what Fortune considers the fifth most important private company in the United States.
Now along the way, he also became one of the 100 most influential people in the world according to Time, and one of the 100 wealthiest people in the world according to Forbes. Because his unique investment principles have changed the industry, CIO Magazine is the one who dubbed him “The Steve Jobs of Investing”.
Very important, Ray believes that his success is the result of principles he’s learned, codified, and applied to his life in business, and certainly at Bridgewater. Those principles are detailed in his new book, Principles: Life and Business. I highly, highly recommend this book. It has already changed how I think about making decisions in my life, and in my business, how I think about managing, how I think about communications between teams, I could go on, and on, and on.
It features … Just check out the blurb from Bill Gates on the cover, and it’ll give you an idea of the type of people who listen to Ray very, very closely.
In this interview, we cover all sorts of ground, including how Ray thinks about investment decisions, how he thinks about correlation for instance, and so on, the books he would give to every graduating high school or college senior, how he might assess something like cryptocurrencies, walking through the thought process, and much, much more.
We do get into his back story and how he became an investor and so on. If you want to just jump right into a bunch of nitty gritty investing detail, which does get into the weeds, then you can jump about 90 minutes in, but we do cover a lot of really good stuff, and many principles that apply in the first 90.
I suggest that you listen to the whole thing, but if you’re super impatient, and you want to jump around, you can jump about 90 minutes ahead and check that out. I hope you enjoy this as much as I did.
Without further ado, here is Ray Dalio.
Ray, thanks for coming on the show.
Looking forward to it. Thank you for having me.
I have been such a follower and fan of your work and your writing. My audience has been asking when I would reach out to you to have you on the show, so this is a very exciting moment for me. I would love to start at the beginning, because it seems like we have some, at least, shared geographic beginnings. Where did you grow up, and how would you describe your childhood?
I grew up in New Hyde Park, Long Island, and I would describe my childhood as being middle class or maybe a little bit lower, middle class family. My dad was a jazz musician. My mother was a stay at home mom. I was an only child.
Were there any formative experiences you had, say up until the end of college, that ended up informing your decision to become involved with investing?
Yeah. When I was a kid, I used to caddy. At the time, the stock market was hot. When I was 12, I got hooked on the markets. I bought a company that … Everybody was talking about the markets, and I decided I would take my caddying money and put it in the stock market. I picked a stock, the only stock I knew that was selling for less than $5 a share. It was kind of a stupid idea, but I thought if I bought more shares and it went up, I’d make more money.
The company was about to go bankrupt, and somebody came along and acquired it, and I tripled my money. I was lucky, and I was hooked on the stock market, so that had a big effect. From then on, it drove my whole addiction to the game, and everything I’ve been doing since, related to my career.
I think that many people who are listening to this, who know your name and your bio, have the impression, perhaps, that every time you’ve stepped up at bat, you’ve hit home runs. It’s just been an unending streak of home runs. I’d like to maybe humanize the experiences you’ve had a little bit by talking about 1982. I’ll back into it by reading just a short excerpt from your book, which I think paints a good picture.
It begins with…
“So there I was after eight years in business with nothing to show for it. Though I had been right much more than I had been wrong, I was all the way back to square one. At one point, I’d lost so much money, I couldn’t afford to pay the people who worked with me. One by one, I had to let them go. We went down to two employees, Coleman and me. Then Coleman had to go. With tears from all, his family packed up and returned to Oklahoma.”
At that point you were down to one employee, that’s you. To make ends meet, you had to borrow $4,000 from your dad until you could sell your second car. How did that happen? Could you describe what happened that brought you to that point?
Let me first say that, by the way, I’m a professional mistake maker. Being in the markets, or being an entrepreneur requires one to bet against the consensus. When one does that a fair amount of times, you’re gonna be wrong a fair amount of times. I’ve learned a lot more from my mistakes, so I just want to let you know that any perception that being right is part of it, no … The main thing is knowing what you don’t know and how to deal with it.
Anyway, what happened at the time is I analyzed the payments that countries owed banks. I calculated that those countries were not going to be able to pay the U.S. back. It was a very controversial view at the time. As a result of that, I took positions in the markets. I got a lot of attention, because Mexico defaulted on its debt, and not many people had expected that, and I did, and I had these positions on.
I thought we were gonna go into a depression. I thought the stock market was gonna go through the floor. I just didn’t understand, really. The stock market rose, and this was after I had testified to Congress and I was on Wall Street Week, and then I lost the money that you referred to, and that’s how it happened.
In retrospect, it really was the best thing that ever happened to me, because it gave me the humility that I needed to become more successful. That was because I shifted my attitude from thinking I’m right, to asking myself, “How do I know I’m right?” That opened my mind a lot. It made me look for people who disagreed with the smartest, and it also made me manage my risks better and so on.
That’s the story.
I’d like to dig into mistakes. I think this will be a common thread throughout the conversation. I’ve read, and correct me if I’m wrong, but that you’re a fan of, for instance, the book Einstein’s Mistakes: The Human Failings of Genius.
He was one of the greatest minds of the 20th century, made a lot of mistakes. You have an expression, “Pain plus reflection equals progress”. My understanding is that at Bridgewater you have, for instance, lengthy assessment sessions, in which employees discuss their mistakes. What type of post-mortem did you do after all that happened in 1982? Or did that come later, the type of post-game analysis that you would do on what led to that mistake?
I think for everyone, and for me at the time, when you encounter the mistake, and you’re experiencing that pain, and there’s an emotional pain, and that was true for me at the time. Then the pain passes, and it requires thought, and making the connection of, “What did I do wrong?”, and being analytical about it.
That was that experience, and that led me to do that as a habit. It became an increased habit. I would literally, every time I would make a mistake, I would develop an instinct. It changed my attitude about mistakes. I think basically, they became like puzzles. If I solved the puzzle, the puzzle being, “What would I do differently in the future?”, I would get a gem. That gem would be a principle that would let me do a better job the next time that sort of thing came about, and I wrote those principles down and refined them over a period of time, which is what makes up my book. But it was that process of making enough mistakes and having painful mistakes that led to an instinctual reaction to have reflections on what I could’ve done different, that led to the progress that I’m referring to when I say “pain plus reflection equals progress.” And I think we all learn. I don’t think it’s particularly just true of me, I mean I think anybody who’s open-minded and smart knows you’re going to learn more from mistakes. There’s so much more that you can learn from mistakes because I mean mistakes … Well, first of all they’re giving you a loud signal, and rewards keep you doing the same things, and so you don’t grow from successes. Successes keep you doing the same thing, so you don’t grow from successes. Mistakes, if you can deal with them in the right way, is where the growth … Plus the reflection is where the growth comes from, so anyway that’s what happened.
Could you give an example from your life of a particular mistake and how you did that analysis or reflection after the fact, and what you learned from it?
Well, I mean, there just so many mistakes. When I was just getting out of college, I clerked on the floor of the New York Stock Exchange, and this is when the dollar was attached to gold, and there was a financial crisis and Richard Nixon gets on the television and says there’s no more attachment to gold. Back then, money was like checks in a checkbook that didn’t have much value, what really mattered was the fact that you could get something tangible in the form of gold that you can make the conversion, so it was a crisis. Our money wouldn’t be taken in other countries and so on. I walked on the floor of the New York Stock Exchange expecting a collapse, and the stock market went through the roof.
It never happened to me before, so that was the case, and I went and researched currency declines in the past, and I learned that it happened before but just not in my lifetime. And one of the things that I’ve learned over the years is that many surprises come because they note things that happened as surprises, never happened in one’s lifetime before. So that it’s advantageous to look at beyond one’s lifetime or beyond one’s own experiences to understand how the world works so that one can anticipate all of those things and learn all the rules of how the world works. That’s the beauty of it, right? And that’s the excitement. To learn how does reality work. What are the cause/effect relationships, and then how do I deal with my realities.
So that’s a case, but there are so many mistakes.
I would like to dig into the research of history, things that have happened out of your lifetime. Because I read that for instance, while on one hand you have Soros who might credit the influence of Karl Popper, who is one of his teachers at one point. You’ve talked about diving very deeply into past periods of economic upheaval, right? The great depression, reading daily newspapers from those eras. Are there other practices or approaches that you’ve taken to examine history? Are there any particular types of books or resources that you go into like that to try to get a better picture of reality?
Before I deal with the particular economic history, I’ll start off by saying, I believe that basically everything is another one of those. In other words, almost everything happens over and over and over again through history, and that the key to success is to identify what one of those it is, and to look how it’s worked in the past many, many, many times. And then to understand the cause/effect relationships to develop one’s principles for dealing with it. So it could be applied to anything. We were talking about economics to talk about politics. Nowadays, we’re hearing the term populous, and populism is something that is a bigger phenomenon than we’re used to in our lifetimes. The time that populism was flourished the most was in the 1930s, pretty much leading up to World War II. And so I use that as an example. I think, “Okay, where were the populists in history? Where were those cases? How does this thing happen? How does it grow? How does it develop? What are the usual linkages, and why?”
That’s been I think very helpful more recently in my understanding quite a bit about what’s going on. It’s affected my perspective, so it doesn’t have to be just reading history books. You know, it’s in anything. People have a new child, and they treat it as though that’s the first time anybody’s had a child. But to gain perspective, you can apply it, gain that perspective of what’s happened over and over, and it could be applied to anything. If you start thinking that way, it’s radically beneficial. That way, when I’m referring to that is, in other words, “What is this? What one of these is it? And how do those things work? And what are my principles for dealing with it?” Then life is a whole lot easier.
If you’re not dealing with it that way, everything is a one-off and you’ll be in the middle of a blizzard of things. You won’t step above those and deal with those instinctual principles. For example, you have your principles. I really admire your stoicism, and I think you could rattle those principles off and you make the connection and it’s connected to your realities.
We each have our own, I don’t want to keep it in the realm of just economics because it applies to everything.
Definitely. I would love to talk about problem solving and I’m sure principles will tie in here, but let’s just say, hypothetically, and I’m sure this is maybe a real case at Bridgewater over many, many years, but if you have someone who’s working at Bridgewater, very very smart, very ambitious, and they’ve made a mistake. And they enter an assessment session. What does the format look like, and how do you help them separate symptoms of problems from the root causes and the actual problems?
I think the first thing that I have to convey is that we have an idea of meritocracy, so it’s not like somebody is called into a room and the people like me or the bosses think that they know the answer.
And that they’re making an assessment of how that person is, and then they write down those notes. No, no, no. Everybody’s equal in having opinion, and by and large, if the person that’s receiving, they receive great and bad feedback. I receive great and bad feedback in a non-hierarchical way. We approach it with the idea of “How do we find out if it’s true?” So it’s got to be evidence-based. And then we will set up tests, lets say if you get bad feedback, we’re down talking about bad feedback, it could be for good feedback. But if somebody’s thinking somebody’s not very good at something, they’re speaking honestly. Most importantly, it’s that people can be radically honest with each other. They’ll say, “I don’t think you’re very good at that.” And they said “I am very good at that”, and then you go through a series of tests to think it’s evidence-based, to try to find out if somebody’s good or bad at that. And then you move beyond it to think, “Okay, well what can I do to get better, or how can I guardrail myself so that if I’m weak at something and somebody else is strong at that thing, we can work together?”
The main thing here is to get at what people are like. This is, to me, it’s a weird world that there’s a phobia about making mistakes, and there’s a phobia about knowing one’s weaknesses. Mistakes are part of the process, and everybody has weaknesses. The greatest people I know have weaknesses and have become successful because they know how to compensate for the weaknesses. They’re aware. The stupidest people I know, least successful people I know, are people who don’t own up to those weaknesses and grow. So the exercises that we’re going through are by people who choose to want to be in a radically truthful, or radically transparent environment, and be evidence-based.
But it’s difficult. It’s difficult because we’re not brought up that way. It takes about 18 months to get used to it, because there’s these subliminal reactions.
Now maybe this is related to the pain button app, maybe not, but could you describe the function of the pain button app and why that was created?
Yeah. It’s like I said, pain plus reflection equals progress. Whatever your form of pain, the best thing to do is record it. This app, the way it works is as you experience psychological pain, you just quickly log it. You don’t analyze it at the time, but you capture it. What was it about? Who was it with? What happened exactly?
The nature of psychological pain is that it passes fairly quickly. The amygdala, this part of the brain, is the part that’s the fight or flight part that gets adrenaline and it reacts quickly. Then over a period of time, whatever the form of psychological pain, it diminishes. That’s an opportunity to reflect. Because it’s been captured in the app, it then can allow somebody to go back and reflect on that and reflect on what you should do about it when the next one comes along. Is it speak to the person who caused you the pain? Is it … Whatever it might be.
You write that down and you record it, and because it keeps in a graphic way a presentation– graphs your pains, the different types of pains and the causes– it gives you sort of a biofeedback that allows you to see if your actions are reducing that pain. That might prompt you to change your actions or it also shows whether you’re following through on your actions.
Let’s say you’re having a problem with the same person doing the same thing causing you pain, but you’re just bottling it up. Then if you choose to keep bottling it up, you’re not going to resolve it. It’s just going to happen over and over again. That’ll show up in the graph. But if you do something about it and you write it down and you can analyze it, and so it provides that kind of biofeedback that allows people to make that progress.
A lot of people have told me that it’s better than the psychologist because it’s there every day of the week and you can see yourself, how you’re … What’s causing your pain, what sorts of pains you have, and it makes it an intellectual exercise to come up with strategies to do those things that stop causing you those pains and get you what you want.
For developing, in addition to using this type of logging tool whether it’s the app or if someone’s carrying around a small journal with them so that they don’t have misremember the details of when they’re triggered for instance, are there any tools that you have found helpful for people in general, employees, yourself?
One that comes to mind – maybe you could chat about and I’d love to hear about any others – is transcendental meditation. I’ve read, for instance, that you’ve said creativity comes from open mindedness and centeredness, seeing things in a non-emotionally charged way. Could you talk about TM and any other tools that you have found to compliment the pain button?
Yeah. Let me say in tools in general, we have developed a whole bunch of tools that would be fun to explain to you in all different ways that are constantly being used. They’re just invaluable. They’re great, but I want to turn my attention to transcendental meditation which unlike, let’s say, an adapt type tool or some other kind of tool is a practice that I’ve been doing for – I don’t know – since 1969, whatever that is. Anyway, a long time.
I think it’s worth noting that everything in our brain, every emotion we feel is physiological. There are chemicals that go through our brains, electronics that go through our brain. They produce these impacts. Transcendental meditation is a practice that takes one from one’s conscious mind into almost a subconscious state and allows one to relax. It’s almost a blissful experience. It relieves all stress, and it brings one into the subconscious mind. Through brain scans, they see that the amygdala which is that fight or flight part of the brain calms down actually, and in some cases they conjecture that it physically changes. The prefrontal cortex part of the brain, which is kind of that more thoughtful part, lights up and is enhanced.
That practice not only creates an equanimity, but by bringing one into the subconscious part of the brain, it significantly enhances the creativity. It essentially opens a passage from the subconscious to the conscious so there can be a reconciliation of those. It’s really from the subconscious where creativity comes from. I mean if you think about it, one doesn’t go muscle creativity like doing a mathematical calculation or something. It’s really like if you’re ultra relaxed. Maybe you take a hot shower and these great ideas come to you or you’re sleeping and these things pop up. They come from your subconscious part of your brain where the intuition and that comes from.
By opening that passage essentially between the subconscious part of the brain and the conscious part of the brain, it’s wonderful. It makes one more creative. It makes one calmer. It makes one almost a little bit like a ninja in the sense that everything with that equanimity seems to be coming at you in a more controlled centered way so that you can react to it well. So I found transcendental meditation to be invaluable.
The specifics here are of great interest to me for a number of reasons. The first is that I practice a few different types of meditation, but I did a TM session this morning for instance for 21 minutes because I find it takes about a minute for me just to stop fidgeting and get settled. When do you typically … Do you do two sessions a day? When do you typically do your TM? Do you have a particular location?
Any specifics of that practice would be very great to hear because TM has come up a number of times – and I find it very secular which appeals to me – from people like Rick Rubin, legendary music producer, Chase Jarvis, extremely accomplished photographer and CEO. What are some of the details of your practice?
Well I think one of the things is don’t over worry about the details too much. Just do it. But the best way to do it is you do it before breakfast and you do it before dinner having not eaten much or not eaten. You do it for the 20 minutes as you point out and that you do it twice a day. That’s the established practice.
I basically do it, let’s say, sort of two-thirds of the days. I would say I probably maybe some days will do it once and not twice, but I also always do it in addition whenever I have that feeling of doing it. As a meditator, you probably know that you can feel the difference. So as you’re going through the day, you carry through almost an ability to shift yourself from a state of mind where there might be a twinge of anxiety, and then you can bring yourself into that equanimity type of state.
But you also … I also find that there’s a time where I say “I need to go meditate.” Then I’ll just meditate. I’ll meditate where I can when I can. I mean I prefer a quiet place, a comfortable spot. I’m not rigid about the location, but if it was standing in my way … My circumstances were standing in my way, I would meditate on a plane. I would meditate wherever I could if it was … If it was noisy and I was on a train, I would still meditate. The mediation may not be as deep. It won’t be as deep, but it is so good. It could be noisy outside and I can still go from one state to another. Not the deep subconscious state but the state of, let’s say, tension to relaxation. That’s how I do it.
For those people who are familiar with transcendental meditation, it’s thought of as mantra-based meditation. So it’s the repetition typically characterized by the repetition of a mantra or a one or two syllable sound that you do not say out loud. Do you sit down and immediately go into the repetition of the mantra or do you take time to focus on your breathe or your bodily sensations before you go into the mantra repetition?
I take a few minutes to settle myself down just as you’re describing.
Yeah, just as you’re describing. It feels good at that moment, and then you go enter it.
Got it. And you mentioned before we delved into the TM, other tools that you and the people at Bridgewater have developed, I’d love to hear you describe any of those.
Those tools are … People carry around an iPad with them, and whenever we go into meetings, there’s a tool we call a dot collector, and it’s a very easy tool to allow people to express what they think is going on and how people are doing. And so in all meetings, there’s this data that’s collected that shows what everybody’s thinking while the meeting is going on. Now, it’s invaluable in many cases, because you’re seeing what everybody’s thinking, so it’s so different and in an ordinary meeting, it’s silent, largely. There’s one person speaking at a time, and you don’t know what the other people are thinking.
In this particular case, what you do is all the time, you see how people are seeing things differently. And so what we do is we take that data as it’s happening and, the computer does, we have it programmed with algorithms that will look at that data, and we’ll then communicate back to them advice. ‘Cause they– this computer mind– will then use that to know how they think differently. And by the way, it’s enlightening. You would have no idea how differently people’s brains are working in a meeting, or work in general. The things they pay attention to, they ways they interpret it are startlingly different. And they have the same kind of patterns to them. And so that discovery allows people to know how they see things different, and appreciate how other people see things different.
And then when they take that, then that allows them to know how to interact better. So the computer, through this iPad, is doing processing in the background, and it will then also coach them. In other words, when they’re dealing with somebody else, or there, it will provide guidance, it will provide feedback that’s continuous. So it’s a tremendous tool, but because you know what everybody’s thinking, it’s analyzing how everybody’s thinking, provides that feedback, and gathers information across all of those people and processes it by being able to see relationships that no one person sees. So it’s invaluable in an idea meritocracy. We also use it for making decisions. We do something that we called believability weighted decision making.
Yeah, if you could elaborate on that I’d love to hear more about it.
Well you want to have an idea meritocracy. If you and I were partners, and we had a group of people and we were partners, how are we going to decide on the best things to do? We’re … I think we’re gonna want an idea meritocracy is when the best ideas win out. You have to have rules for doing that. You have to have procedures. So there are three things you need to do. The first is that you have to put your honest thoughts on the table. A lot of people are hesitant to do that, they keep their honest thoughts back. But if you have a culture in which you can put your honest thoughts on the table and everybody does and that’s the way it operates, now you see what people are really thinking. Great, that’s a good first step.
Second step is you have to have thoughtful disagreements. You have to know the art of thoughtful disagreement. So there are processes that we go through in which people are really hearing each other, and as you go through that process, to make better decisions than they could individually. And then the third thing is, if disagreements remain, you have to have idea meritocratic ways of getting past that disagreement. So how are you gonna do that? In most places, it’s either autocratic or democratic. Autocratic means the one with the power makes the decision. The boss makes the decision. Democratic is one man, one vote, and it treats everybody as though they’re equally valuable. So we do what we call believability weighted decision making. We have ways … Well let’s just imagine what it is before we get to how we get to it.
Imagine you knew each person’s believability, who’s a better decision maker at what. So I’ll use an example … if you had a medical condition and you went to doctors and you had a friends, well you would know your doctors better than your friend, and some doctors are better than other doctors. And so, consciously, you’re probably weighing those decisions with consideration given to their believabilities. In our place, we have ways of determining people’s believabilities in many different dimensions. Maybe if it’s an accountant, they would have greater believability in accounting or maybe if it’s somebody who is more creative, we’d give them, there are more points that they actually get and they know that that person’s more creative. And somebody else might be more reliable and would work well with the person who’s creative, and so what we … because if we have this believabilities according to all those dimensions, when we make a decision, we make a believability weighted decision.
We literally, on the iPad, say would you do this? And then everybody votes, and it calculates what the vote is on a believability weighted basis as well as on a absolute basis. And that idea meritocracy not only produces better decision making, but it also produces a fairness that everybody believes that the system is fair. And that is invaluable, because when you have disagreements, or you even have assessments, which people are sensitive to, and you do that in a way that everybody agrees are, is fair, that means that they will go along with it more, that they, that the game is fair and it’s … it works much better in getting past disagreements. So as I said the third step is how do you get past the disagreements if they remain, and we try to do that in an idea meritocratic way through believability weighted decision making.
What are some of the rules or guidelines that you have for preventing disagreement from devolving into highly emotionally charged fighting? In other words, is it similar to say, non violent communication? Are there specific rules that you think perhaps listeners could also borrow that you found to be very helpful for a thoughtful disagreement?
There’s a whole series of protocols. For example, there’s what we call the two minute rule. Two minute rule means that if I say the two minute rule, I’m allowed to speak for two minutes without an interruption.
And you said the two minute rule, you’re allowed to speak for two minutes without an interruption. There are protocols like you repeat what the person is saying. You must repeat what the person is saying and the points they are making. So that it demonstrates that you’ve taken in and understand what they’re saying. And then you repeat it. We allow disagreement to take place in different formats. It might, rather than being in person, if it, if somebody maybe is too emotional in the moment, or maybe they’re not good at thinking on their feet, we allow that disagreement to take place in a format that’s essentially the equivalent of email exchanges. In other words, in written format.
Anyway, there’re a bunch of those kinds of procedures. They mutually agree on who an arbiter is. In other words, whenever there’s a disagreement that you can’t seem to get by, as a standard practice, the protocol is to say let’s find the person we can agree who will be a moderator, and help us through that. And because they mutually agree on that person, then the rules of fairness are an easy thing to do. So there are many of those types of protocols that we use. It’s also culturally like a big faux pas, or a big thing to lose your cool, in that way. You know I mean culturally, okay, it’s … Maybe you need a time out. So all those things enter into it.
No, those are very helpful and actionable. And I’d like to look at the dynamics of making decisions as a solo operator, or close to solo operator just as a compliment or a contrast. If we flash back to when you first began Bridgewater Associates, so out of your two-bedroom apartment at 26 years old, do you recall any of your first big wins, or things that you considered big wins, at the time? I’d love to just hear you describe what made those a big win? In other words, the thinking behind it.
You know, the funny thing is, I can hardly ever remember my big wins. I do remember my big losses, or big mistakes.
We could talk about those, too. Yeah.
It’s so funny because I look at it, and I said, “Well, I guess I must have had a bunch of wins or successes because of how things have went.” The business is good, and I’ve done well, and all of that. But, I think of my history and I really think of those mistakes and I think that’s so great, because it shows that that’s a much better learning tool.
Okay, so my big wins. You know, no, I think about that, at that time, I think, no, the things I remember were the fun things, guys I played rugby with, and parties, and those kinds of things. I don’t remember a particularly big winning … Well, I do remember some things. I remember one time when we got the Kodak account. The position is, here’s a guy and he’s analyzing the markets, and then, he has a small team of people who’s analyzing the markets. So, I didn’t have a long track record, and I didn’t have a institution, and sort of competing with the big institutions of the world, the JP Morgans and everybody and, by the way, we beat them.
But, anyway, which shows that the individuals, the powers within the individual, but anyway, I remember when we got the Kodak account. Because, at the time, Kodak was a big important client, and them giving us that account was a big deal for us because it was kind of a stamp of institutional approval, and it was … All I remember is that the money mattered, too, because we would know that we were a bit more financially secure, so I remember that as a big win.
I remember it so terrifically because we were asked to submit research information, and we were just a small team of people. We stayed up all night and with pizza and beer and all of that. I remember it so sweetly because it was the dream of making our miracle happen and pulling together. That’s the meaningful relationships part. I believe that I want meaningful work and meaningful relationships, and so, that was what that was about. We got the account, and we won, and that was a big deal.
Why did you guys win?
I think it’s a combination of being totally unconventional and having better processes, and then, there’s a hell of a lot of determination.
I think three things make up a successful life by and large. First, you have to have audacious goals, big dreams. Then, when you are headed toward those goals, you’re going to have problems, you’re going to deal with reality. You have to deal with those problems and that reality realistically, learning from mistakes, writing down those principles, and the like. That’s the second part, dealing with reality in a practical way where you learn about mistakes. The third is determination because if you’re going for your goals, and you’re encountering your mistakes, and you’re learning, and you do that with determination, you’re going to get better all the time. You can’t help but get better. You do that a long enough amount of time, and you’re going to far exceed your dreams. My success has far succeeded what I ever imagined one bit at a time and it’s just that process.
If you were to conversely look at intelligent people who are unhappy, what do you think the primary causes of that unhappiness are?
I think it goes back to this notion of meaningful work and meaningful relationships. Intelligence and happiness probably have no correlation with each other, and studies it’s repeatedly been shown, and money is very little correlated with happiness. The highest correlation with happiness is community. Am I part of a community? Do I feel connections with other people?
That’s been literally genetically programmed into us from, it’s estimated, between a million and 2 million years ago before we were even mankind, so that sense of meaningful relationships, I think is very, very important. If you have meaningful work, like you’re on a mission, and you have meaningful relationships, I think it’s almost impossible not to be happy. I mean there’ll be unhappy moments in your life that you would encounter this thing or that, but the people who are unhappy seem to be missing those things.
I think this might be a good place to give listeners a little bit of background that they probably don’t have, which is a conversation you and I had that I really appreciated when I was very nervous at TED not too long ago, doing a rehearsal of my talk, which explored some of my experiences with manic depression, and even a close call with a near suicide in college, and you were very kind. You came up and spoke to me after I came offstage.
I was hoping perhaps you could talk about some of what you shared with me, and perhaps your son’s experience, and what he’s found helpful in mitigating some of these darker or harder moments that he’s also had.
Sure, I’d be happy to. I should say that when I described unhappiness in answer to your prior question before, I was not dealing with those who has clinical depression, which is also a different thing. It is a chemical reaction having to do with serotonin, dopamine coming in spurts and sputters and so on. There’s a physiological element that is driving it, so that’s a big thing.
My son when he was, I think, about 27, filmmaker, very creative, was in his new job in Los Angeles. Very excited, stayed up all night, smoked marijuana, partied all night, very energetic, and basically went crazy. At the hotel, he took the computer that was at the reception, and smashed it. The police came, he was rebellious, they beat him up, and so on, and so forth. We then began our journey through three years of his bipolar episodes. That was an incredibly difficult and eye-opening and, in retrospect, wonderful experience. Some of the most painful experiences in retrospect give you appreciations that you wouldn’t otherwise have. That was that experience, and so, ask your questions pertaining to it. I’d be happy to tell you.
The quick answer to this, by the way, is he did things right, eventually. He made a lot of wrong things in between, but he came out of that three-year period, and he became a successful filmmaker. The first movie he made was called Touched with Fire, which was love story with Katie Holmes, bipolar. He has, through that movie and his speeches and so on, we know saved a number of lives, and also helped to really destigmatize that because those with bipolar are often very creative people. I learned that genius, creative genius, is at the edge of insanity. Anyway, what questions do you have about that experience?
I’d love to hear what your son has found to be helpful. In terms of tools, or resources, approaches, routines, anything. That he’s found to help him better navigate, and manage everything that is part of his makeup I supposed. Much like it is part of my makeup.
Sure. There’s these really four protocols, and I gave him a Saint Christopher metal, and on the back I put the initials of those four protocols. So that he would keep it close to him, and so I know them well. First of all, the first one we have TM, those are the initials. And that represented “take medicine” and by the way, the amount of medicine that he’s taken has, because of his improvements and so on, has diminished quite a lot.
But take medicine, and it also represented TM, transcendental mediation. So do the transcendental meditation, and take the medicine. No drugs or substance abuse. None, be clean. Go to bed never too late. It’s not a matter of just a eight hour sleep, it’s we have our rhythms, and that basically go to bed by 11, and maybe once a week you could be up ‘til one o’clock in the morning.
And then what we call “monitoring”. Now monitoring is much less important to him now, but at the time his being open about his bipolar, and having people around him know, and actually sort of monitoring his behavior. So that they can raise a red flag, and help him deal with that, if he was going in one way or another. But those were the things that were very helpful.
In addition, have to be very careful about changing time zones. So if you’re flying to Europe, or far away. You have to do that in a way that you pace it, so that it doesn’t get triggered. And as I said, he went through this. You would never … He’s now, one of the most centered people I know. Happily married, given us two grandkids. It’s just been a miracle, and I really do believe it’s that combination. And he’s learned, and shown other people that, that combination could work for anybody.
That’s extremely helpful, and I think valuable for a lot of people listening. And I want to reiterate something that you mentioned, because I only realized it in the last maybe two years. And that is the going to bed earlier. I’ve always been very, very nocturnal, and a night owl, and particularly say on book deadlines, and so on. Going to bed at four or five, six in the morning. Waking up very late.
And that has historically absolutely been correlated with a much more severe and extended down times. So I do just want to reiterate what you said, which is that going to by say 11 o’clock has for me at least been extremely helpful in mitigating a lot of what we’re talking about.
By the way, it is so great that he is open, and you are open, and you can communicate it. Because I found out … You know that 24 percent of the population in one form or another has been diagnosed with some form of mental illness. Some form of challenge, because the brain is like an organ. It is an organ, and it has those things.
And some of the most creative people you would know that… Abraham Lincoln, and Winston Churchill, and Tchaikovsky, and the list goes on and on. Of unbelievably great, brilliant, creative people simultaneously have been challenged by this. And by making people aware, and in one dimension or another. Either whether they’re dealing with somebody who has such a challenge, or to de stigmatize it, and realize …
I look at you, what a role model you are, and by being open about that particular challenge, people can really appreciate that. We have a number of bipolar people who work here, and when you know how to deal with it, there are tremendous advantages to it too. Because it’s a way of thinking. I mean there’s these mood shifts, but there is also an unbelievably high percentage of those people are creative.
So, and certain professions and so on. But anyway I just want to compliment you, or express my appreciation for you having this conversation, and being so open with it. And I’m sure you would say, as my son would, it’s very helpful. Because when everybody around you understands it, it’s helpful to you too.
It is helpful, and I really appreciate the kind words, Ray, and I should also mention that for decades I kept this secret, and close to the chest. And I was very ashamed of just the nature of how my physiology worked ultimately. And I was so fearful about talking about a lot of this publicly, and even the TED Talk was …
I had a very separate, very different TED Talk that I scrapped a few weeks before hand, because I felt morally obligated to talk about this more publicly. And in doing so, felt quite the opposite of what I feared. It was actually an enormous burden and weight lifted off of my shoulders. And it’s really been liberating to talk more freely about it.
I understand that completely, because that’s what my son does. I mean that’s my son’s reaction. If you want to talk about it, in a more serious way, I’m quite an expert on the whole thing. The best doctors, and I really believe that I could probably be of some help if you feel that it’s not entirely under control.
Thank you, no, I appreciate it. And it’s to segway a bit here, so absolutely appreciate the offer, and that’s something I’ll remember. You seem like a very astute cultivator of talent, and what I’d love to know is if there were any particular mentors of your own. Who you could describe, or share with us? That could be very early on. It could be in your investing career. But any mentors who come to mind, and what they taught you, or help to cultivate in you.
I remember nice, kind people … Not a mentor. I couldn’t go to a mentor, but I remember somebody who when I was caddying, and he was clerking on the floor of the New York Stock Exchange. A very successful Wall Street guy, and I used to caddy for him. And we would talk about markets, and he gave me not only advice, but it was the kindness, and the caring, and the direction that was helpful.
I don’t know that he was an ongoing mentor, but he was a role model in many ways, and did provide guidance. So maybe I think, maybe he was, but not an ongoing mentor. I remember teachers that served that role, but not much. Most of my learning has been from mistakes. I have a terrible rote memory by the way. I mean it. Terrible. Anything that doesn’t’ have a reason for being what it is, I practically can’t remember.
I can’t remember phone numbers, names, anything along those lines. So I tend to learn not by being taught, or going to my memory. I learn through my experiences, and my kind of more subliminal memory.
It seems also that you’re well read, and I’d love to actually just go back for a second to Einstein’s Mistakes. When you pick up a book like that, it’s two questions. Number one, how did you chose that book, or find it? And number two, is how do you read? What is your reading process?
The book was given to me, ‘cause people know that I like that stuff. And the way I read, it depends on what I’m reading, but I will kind of skim, and it depends on how much time, and a lot of things. But generally speaking I’ll try to go through a book pretty quickly by being able to sort out what the main ideas are. From the digression. So, there’s this kind of little bit of a strategy.
You know how they’ll tell you the story, and the story might go on for a while. And then it then gets to the point they’re trying to make. So when I’m going through the stories, I might go quicker. I might be scanning for the top of the paragraph, to get an idea what they’re doing and then go into the section that I’m most interested. I would say I would be typically reading that way, unless it is something in which there’s not that sort of a book. That there’s either something where I’m enjoying the flavor of the wording and the sentence structure and the beauty or the thoughtfulness in that I really want to take that in and I don’t want to scan. I like to get the most out of each book as quickly as I can because the number that I’m trying to go through is comparatively large. So I’ve got a pile of books here sitting in front of me and they torment me because they tempt. I’m very curious. I would say curiosity is a big motivator for me. The world is got much too much to offer relative to my capacity to digest it.
What are the books that you currently have in front of you or that are sitting there like undone homework assignments? What are you currently have on the roster or potential roster?
This is fantastic.
I do mostly original research. So in addition to looking through books and going through it, I really like to get into the data, I’m a researcher basically.
Is there anything that you’re researching right now or that you’ve researched recently?
The bottom 60% of the population and what the world, life and the economy is like for them because there are two different economies in the world, the averages are very, very misleading. The top two tenths of one percent of the population has a net worth, which is about equal to the bottom 90% combined. So I’m researching more about what that’s like and it’s quite a bleak, difficult picture, so that’s the thing I’m researching right now.
What drove you to research that? Is it just to understand the implications and secondary and tertiary implications of that or was there something driving that?
I think right now we’re in the midst of an era that’s very much like the thirties, in which wealth and opportunity gap and the populism that’s coming from it and the divisions, which are great, I mean large is a defining moment of our time and this exists around the world. If economies were to go down now, I do believe that there would be a great deal of conflict and I think that we’re seeing the conflict play out politically, not only in the United States but you’re seeing it in different places or interactions. I think it’s the defining issue of… maybe that’s over reaching… but it is certainly one of the most important issues of our time and I mean this year, next year, the year following because that’s the basis at which are we going to have conflict or where one side is fighting the other side.
This is a matter of principles, we’re talking about principles again. Are the principles that hold us together as Americans, greater than those that divide us? How are we going to be with each other? So this understanding and all of these perspective I think is very important at the time.
I’m definitely going to come back to a related thread on that but before I get there I wanted to ask you of the books that you mentioned that you were not gifted, how did you or why did you choose any of them like The Greek Hero, The Undoing Project, Sapiens, From Bacteria to Bach and Back, any of those why did you choose them?
I would suppose that each one is different because of the themes of interest. I’m fascinated by evolution. I think evolution is the greatest force in the universe and the purpose of everything is to evolve. We as individuals are just vessels for our DNA is evolving. I’m fascinated in evolution. I’m fascinated in how the brain works. The Greek Hero’s very, very, very interested in terms of one of the greatest books is Joseph Campbell’s, Hero of a Thousand Faces. Which takes the character of going through life and what are the attributes that different people have, so difference in values. So it’s an eclectic group of interests. I’m interested in nature a lot. So I tend to … I’m also particularly interested in the ocean, so I will read about nature in the ocean. These are just curiosities, but they become themes I guess. I’m not interested in cooking. I’m not interested in a whole bunch of things, so they do come in these categories.
Are there any particular books that you could mention and don’t worry I won’t belabor the book stuff forever. But any books you mentioned Joseph Campbell, that have had a string impact on your life or your thinking? Maybe a way to frame that would be if you were and certainly one of the books in answer to the question that I’m about to pose could be your own certainly. But if you were to give say every graduating senior in college or high school a handful of books, what might you give them?
The books I’d give them would be, Lessons From History, this is the Durantes, they were maybe the greatest historians of all time, any way, wrote 5,000 years of history, probably wrote 5,000 pages and they took this book I think it’s 104 pages, and they took the themes of history, it could be from religion, natural resources who knows, each one of these things. And they looked at it for themes of history through history. I think that, that would be great. River From Eden by Dawkins, Richard Dawkins. Another very short book on evolution, it just really puts things in perspective. Again, I would say Joseph Campbell’s, Hero of a Thousand Faces. Those would be the three books that I would say that would be the combination. The beauty of particularly two of those books is, it’s not going to take long to read them. Hero of a Thousand Faces little bit dense but it’s so rich, so it’s a good one.
Why is it… these are fantastic … I need to get on buying those as soon as we get off the phone but, why is it, and maybe this isn’t true across the board but whether it’s in early stage start ups or in the realm of say broadly speaking hedge funds or asset structures or asset management, the best investors that I’ve met almost all have a fascination with evolution. Why is that?
Don’t have a clue. I didn’t even know that.
I didn’t know that.
All right then we don’t have to dwell on it. For whatever reason yeah, it just seems to be a pattern. There are a few maxims I’d like to ask you about and if these are misquotes, please correct me. The first is ask yourself whether you’ve earned the right to have an opinion. Can you elaborate on that?
Yeah, all you want is the right answer, right?
And there’s such a bias to think that just because you have an opinion that it’s valuable or to be so stuck with it. That’s really stupid, right? In everything, you just want the right opinion where ever it’s going to come from. So if you gain humility, I believe that one of the greatest tragedies of mankind, individuals is to hold wrong opinions in their head that so easily could be stress tested to find out if they’re right or wrong. If you can sort of give that up and think, “How do I know I’m right?” You’re going to significantly raise your probabilities of making better decisions. I mean, that’s the big thing. The only two things you need to do in life in order to be successful. First, you need to know what the best decisions are. Second, you have to have the courage to make them, to do what’s necessary. On the first, the greatest problem is that people just look inside their heads for their opinions where they can really get rid of the bad ones and take the best that they can get elsewhere. By doing that, by exploring different people’s views, not just their conclusions but the reasoning behind their conclusions, they can learn such a tremendous amount.
We talk about books. Well, conversations are much better than books. You can have those conversations and learn when people have differences and just pick the best opinions, right? Isn’t that sensible?
Yeah, no, it’s definitely sensible. How do you … What are some good questions that someone can ask to explore someone’s reasoning behind their conclusions? I think that it’s so easy for people to become charged. Are there any good questions, for those people who … The vast majority are not going to operate within say Bridgewater Associates. What are some good ways to explore or investigate someone else’s reasoning behind their conclusions?
Well, I think the real driver of it is when there’s a difference of opinions to … Do you have a real curiosity to understand why? It’s really through the fear of being wrong combined with the curiosity of wondering why somebody would have another opinion. That becomes the motivator and so you kind of ask why, and you think, does that make sense? Then come back with other questions. I would say I think most people are … Too often, they start with opinion. There’s psychological tests that show that people start with an opinion and filter information that comes to them to be consistent with their opinion.
Right. Yeah, well, then you’re not living in reality, you’re living in a sort of illusion of confirmation bias. Right?
Right. Besides being so damaging it’s so much less enriching.
This, I think, is related in a sense to, maybe, another maxim that I’d love for you to elaborate on which is don’t pick your battles, fight them all. What does that mean?
That’s one of the most misunderstood so I’m glad you asked me because it’s clear that many little things are symptomatic of bigger things. Under that principle it explains if somebody’s behaving in a certain way and you think, “Well, that’s not a big thing,” but you don’t understand why somebody would do that, it may be symptomatic of a bigger thing. When you start to, almost I might say, pull every thread, as you start to pull the threads you start to see the connections. Because you’re chewing to get at what’s everything symptomatic of. That’s what you’re really trying to get at. Is that what is the person like? What is that situation like? Why would it manifest itself that way? It’s probably a principle that throws people off and I probably haven’t articulated very well.
What are some of the biggest challenges that you’ve had within Bridgewater at different phases of its development? Were there any particular sort of forks in the road that are memorable to you, where you had to improve or fix something?
I’d like to start with the overarching challenge that is a constant challenge, and then we can go back to some of the actuals at various forks in the road. The overarching challenge is people’s two thems, in other words think about it in this way: there are two yous inside you. There is the thoughtful you, prefrontal cortex type of thoughtful you. Then there’s the subliminal emotional you, and you’re not aware, actually, of the subliminal emotional you. That’s why it was Freud’s great discovery in that there’s this subliminal that’s really controlling you but you’re not in your consciousness. There are those two yous and they’re often at odds.
The classic example would be, of course, something where you did something that you didn’t want to do. You ate the cake that you didn’t want to eat but, anyway, or you punched somebody or something. There are these two yous that are in a battle for each other. What we’ve observed on a constant basis is that, in addition to having disagreements between people, we see that that emotional subliminal them often can be in control of their more thoughtful them. Those are ongoing battles.
That’s basically the battle. That’s the battle that almost everybody all the time is doing. Imagine how confusing it is. You have two yous within you that are battling with each other. Then somebody else you’re dealing with has two within them, and so it can get difficult.
Every conversation has at least four people involved.
Yeah. So that’s it. If you can know how to deal with that that’s a constant struggle. The thing that we find is that very, very few people have a problem intellectually liking what’s going on here. It’s fair, it’s honest, there’s no politics. Anybody can, in an idea meritocratic way, can argue their case. It’s not hierarchical. It’s fantastic in all of those ways. The challenges that they have are then with their emotional you reconciling with their intellectual you, and that’s an ongoing challenge that’s all the time.
That’s a theme, I would say, is a constant theme. Okay, well then, twists and turns, at every phase in life you have different challenges. I mean, not having any money, any resources, and then having to do things from myself. You’re an entrepreneur, no money, no resources and then having to do … Buy the computer, rent the place, do all of that was one kind of challenge. Then you have the small team and you have those dreams and you work with them and it’s fantastic but you didn’t have enough resources. Then you grow and you have the exact opposite things happening to you and they produce their own challenges. You have too many people and you don’t get to know each other as well as you did before but you have plenty of resources but you might have the challenge of how do you maintain that quality relationship with that large a group of people.
Then one has to figure out how you … We have 1,500 people that work at Bridgewater… how does that connectivity, that same kind of excitement and mission and togetherness that happened when we had five or 50, how is that maintained and that’s a new strategy. One always has these different problems and the various inflection points that lead one … There are the forks in the road that are the points that you’re referring to and they’re the junctures your referring to. There’s just so many of them.
What I’d love to maybe dig into is a word that gets used a lot and I’d love to hear how you define and think about risk specifically. I have a quote here that maybe we could use as a jumping off point. I’m not sure exactly where it’s from, but, “Risky things are not in themselves risky if you understand them and control them. If you do it randomly and you are sloppy about it, it can be very risky.” Then it goes on. Their words, not yours. The key to success, their words, is “figuring out, ‘Where is the edge, and how do I stay the right distance from the edge?’” How do you think about risk because that’s a word that a lot of people throw around. I have a feeling that you think about it maybe in more specific terms or more clearly than a lot of folks. How do you think about or define risk?
I think the most important thing is there’s the risk of the ruin, risk of being knocked out of the game, risk of the unacceptable, and then there is risk of the painful mistake and their world of difference like I have to know how not to die, not how to get knocked out of the game. That’s an important risk, so thinking about all the different ways that that can happen and making sure all of those ways are covered is number one.
Then, there is the other kind of risk, which is take it. Have the experiences. I guess maybe the example would be if I was saying skiing comes to mind. Don’t kill yourself, but if you’re not falling a lot and hurting yourself a lot, you’re probably not learning. To distinguish between when you risk-averse, be very risk-prone in terms of being able to have the experiences that are the learning risky experiences that even produce some of the pains that allow the learning, but don’t get knocked out of the game.
Then, I think of risk as, “How do you do that? How do I improve my return-to-risk ratio?” I know that, the most important way that you can do that. There’s a few ways, but one of the most important ways is knowing how to diversify one’s bets without reducing one’s returns. There are a bunch of things that are equally good, and you know how to take all those equally good things, but they’re not correlated would mean that I could do a much better job.
Just to give you an idea, think of something as being correlated like something like some … a bet. Something. We think of that as correlation, but you can almost think of it as a different kind of bet. If it is 60% correlated, and you start with a particular level of risk, and you add in the second, and third, and fourth, and fifth, and a thousand different items to diversify yourself, you will only reduce your risk by about 15%. Maybe a little bit more than 15% if they’re correlated.
If you do that with uncorrelated things, uncorrelated bets, at 15 uncorrelated bets, you will reduce your risk by over 80%. So now, the holy grail of investing, the thing that I learned and that’s the most important is that if I can have 10 or 15, ideally, 15, but even if it’s five good, uncorrelated bets, that’s the holy grail. The holy grail is 15 good uncorrelated bets because it will … If they’re all equally good and expected return … In other words, let’s say they were all going to have an expected return of 10%, by the way of example, on average. You won’t lower your expected return because they were all on average about 10%, but in terms of the risk, you will eliminate 80% of the risks, so you improve your return-to-risk ratio by a factor of five.
What I’m saying is that knowing the value of uncorrelated bets is incredibly important. When you’re thinking about it as a business, i think about it as … Basically, a betting strategy in every one of the bets that I make, but if you’re thinking about, let’s say, your businesses, if you can create good, but uncorrelated things, that power of diversification is so much more valuable than trying to make any one bet much greater.
I think about diversification, and I also think that in terms of, let’s say, bets, we’re raising my probability of being right. One of the most important ways of raising my probability of being right is not being confident that I’m right and being able to go out there and gather the triangulation, so something for me is it … Technique is quality triangulation, basically. If I can find three people … I don’t know… let’s say it’s a medical condition, but it could be any decision.
If I can find three people who are excellent experts who will disagree with each other because they’re committed to the right answer, and I can get triangulation and also listen to their disagreements, I’m significantly raising my probabilities of being right, so there are techniques like that. Humility and triangulation of great people is an excellent way of raising one’s probability of making good decision.
I’d love to unpeel the layers a little bit on uncorrelated bets. What I’m wondering is … so I think about this just say in my own life with various types of investing and I’m by no means anyone with a track record like yours, but how … The question that comes to mind for me is … or the observation rather, and I’d love for you to smash it to pieces if it’s not accurate, but that with a limited dataset, you can, if you’re able to crunch some numbers, identify say things that go up at the same time or down at the same time so the correlation or that are inversely correlated, so when A goes up, B tends to go down. At what point do you consider yourself confident something is uncorrelated because it seems like you would need a much larger dataset to conclude confidently that something is uncorrelated?
I think there are two ways of determining the correlation … that they’re uncorrelated, and that is, are they in … You referred to the first, but I think it’s the worst. It still has value, which is, how did they move together in the past? I think the more important is to understand like, are they intrinsically different things? If you were going to say, “I’m going to invest in this Silicon Valley startup and timber in Colorado or something.”
You know that those are intrinsically different things, and I think you can get a good sense of that by just even knowing what they are. That particular startup will have a particular thing that will make it successful. I don’t know what we could imagine it might be, but it might be having nothing to do with something else. Now, I think of, “What are the fundamental determinants of the price movement?” You don’t have to get so precise about it. I like to think it through probably maybe an overly-analytical way, but knowing that they’re intrinsically different is good enough. Now, back to your question of the dataset. It then becomes a … I’m going to give you a more complex answer than you probably want, but …
No, I love complex. Let’s do it.
Okay. It has to do with a combination of sample size and environmentally biases differences. In other words, first, how much sample size do you have? Is that over many years, or did they have something in common that would affect them? If I have many years and a large number of samples in that number of years, I can have a higher level of reliability if I’m just looking at the numbers than if I had a short-term period because correlations will change.
Is it a number of years, and is it in a different environment? I have a rule in terms of most of my decision making. It has to be timeless and universal. Timeless means if I take a period of time, with the correlations or that which I’m discovering, true in all of those periods of time. I like to go back a long time, but let’s say you have a limited amount of data. That’s a handicap. The more data you have the better, but still, if I change the periods … In this year, did that correlation … Was it the same as the correlation in the prior year, and was the correlation the same in the year before that? The correlation, let’s say, of daily returns? Or, you could have correlation of minute returns?
So, timeless, and as far back as you go, and I like to deal with universal. What I mean by universal is that if I have a decision rule, or equities or bonds or an asset class or something, and I see its behavior, did it behave the same in, with the same drivers, in another country, in another country? Were the correlations, for example, between stocks and bonds in Spain similar to the correlations between stocks and bonds in Brazil, similar to the correlation between stocks and bonds in the United States?
Okay, that’ll give you more of a sense that the correlation between stocks and bonds is X than if you have just it happening in one place. So, timeless and universal are just, for most decisions, are rules that I look at, but at the end of the day, I get really more comfort by being able to understand the intrinsic determinants. So, if I’m talking about investments, because that’s the subject. We can talk about a lot of other things, but anyway, if I’m talking about correlations of investments, every investment is a lump-sum cash payment now for an income stream in the future.
If I buy a bond, I give a lump-sum payment and they’re going to give me so much per month, all the way for whatever the length of the bond is. The majority of them go 20 years or whatever that is. If I’m having a stock, it’s a lump-sum payment, and then we estimate, what are the future cash flows? This is uncertainty about those cash flows, but you will look at those cash flows. They will all be affected by the discount rate, the interest rate, we use to calculate the present value. There will be an intrinsic reason that they will be correlated, and there will be intrinsic reasons that drive their correlation.
Let’s say … If I’m getting too technical, please excuse me, but all of those investments are going to have the interest rate that we’re using to calculate the present value in common and therefore that will drive a correlation between that, while the items that affect their cash flows could be different, and that will drive, then, something that one can analyze and see that their correlations would be different from that attribute. If you break investments down and you look at what the causality is, it’s better than if you’re just looking at past numbers, but you could look at it either of those two ways, ideally both.
For those people who would like to get a better understanding of some of the underlying factors that affect the economic engine so to speak, interest rate, et cetera, what would your recommendation be if they wanted to educate themselves?
I did a 30-minute video called How the Economic Machine Works, in which everything that I know that is of most value describes in 30 minutes. It’s on YouTube, I’d recommend that they go there. In 30 minutes they’ll have most of what I think is valuable in understanding how it works.
It’s a pretty simple machine. It’s like almost anything, if you think about it, most of the important things that are driving almost anything, can be described pretty simply, so that’s what I attempted to do in that video on YouTube.
It’s been downloaded five million times. I mean people … it’s rated highly, so I think it’s helpful.
I will … to everybody listening, I’ll link to that in the show notes as well, so people can easily access that. Just to pose a hypothetical, because I’d love to hear how you approach, not necessarily if it’s a long or short decision, although it could be, but just to hear how you would even go about assessing a potential opportunity. Because for instance, a very primitive compared to how your operation or how you would approach investing, but living in Silicone Valley for instance as long as I have, 17 years now, I have an informational advantage when it comes to choosing and assessing different startup opportunities. Elsewhere, people might have an analytical or behavioral advantage, or fill in the blank, if you were to look at for instance, cryptocurrency, Bitcoin, all this other stuff, how would you even begin to assess that in whether it poses a good or bad opportunity for investment?
Well, everything I look at is, I try to look at who are the buyers and sellers, and what motivates them and what are they gonna do. I break it down, I analyze … now, I wouldn’t know how I would do that in Bitcoin, and I don’t know if it would apply to everything, but as a general theme, if you know who the buyers and sellers are and what their motivations are, how big they are, and so on, you can pretty much calculate … you can go a long way to understanding what the price is likely to do in the future. That’s very different from something like value investing, which is something that says, my lump sum payment today is this, and the future cash flows over the next number of years will be this, so I’m very much more driven to the buying and selling. In terms of something like a cryptocurrency … first of all, not an expert on the cryptocurrencies, I would think that what I’m describing is super important to get at, because there are two purposes of a currency. Any currency is a medium of exchange or a store hold of wealth.
When we think of dollars, you use it as a medium of exchange, or if we’re holding it as a bond, it’s a payment over a period of time, and it’s a store hold of wealth. In the case of cryptocurrencies right now, it’s not a very practical medium of exchange yet. I have my Bitcoins and I try to go spend them and it’s not easy to go spend them.
When we think of it as a store hold of wealth, no, today it’s primarily a speculative market. It’s somebody knowing … it’s not its intrinsic value that you’re going to be looking at. It’s really thinking about who are the buyers, who are the sellers, and what they are likely to do, and projecting that that’s going to be the driver of investing in a cryptocurrency.
Could you talk a little bit more about assessing the motivations of buyers and sellers? You could do it with any class or any hypothetical, but specific example, because I guess in my mind as someone who’s very much a junior varsity with all of this, that the motivations would seem to be, at least if people are speculating, to get rich, both on the selling side and on the buying side. How do you dig deeper than that, and any examples would be super helpful.
Every buyer has behavioral characteristics for certain reasons, so if you say, let’s say stocks, to use a very simple example, a typical individual, maybe mutual fund buyer, will buy after something’s gone up because they think it’s a better investment. They’ll sell, they’ll get scared when it goes down because they’ll get scared, and they think it’s a worse investment. Whereas, a typical institutional investor or pension fund, will buy when it goes down because they have to rebalance their portfolio to keep an asset allocation mix at a certain level. If they’re losing money in something, and making something another, they will rebalance in a mechanical way. There are many different ways of knowing. Of saying, “Okay, who are the biggest ones? Who are the littlest ones?” But most importantly the biggest ones, and, “What are they motivated to do?” And by my understanding, and in that way it’s important. So you have a lot of different buyers, and sellers in different markets for different reasons. That when you examine it, it kind of makes sense. That somebody might … Stock may go public, and then the owners have a window that is closed for them to sell it-
And then the window opens up, and then they’re going to sell at that time. I’m just give you a whole bunch of examples that one can know, or attempt to know. That are more than just people wanting to make money. Somebody squeezed. You have a financial squeeze, and they need cash. So that they’re motivated to sell it because they need cash. There are lots of different reasons.
Right. Meaning a distressed seller in the last case.
Right, and to know on and ongoing basis, that the market is made up of that mixture. And so, as much as one can, it is a good way of getting a sense of that.
Very common where I’m sitting right now. I’m in San Francisco, and so I’ve read, and please correct me if I’m wrong. But from Tony Robbins book, which included you, that I suppose over a long enough period of time, anyone’s favorite asset class … I’m paraphrasing this will decrease by 50 to 70 percent, or something like that.
Yeah, that’s what I said.
Okay got it. So, what are the most important implications of that from the behavioral standpoint of investors. How should that change their thinking, or behavior?
Well it goes back to the point I was making before. That you can come up with a bunch of equally good investments. I mean generally speaking, all investments are competing, and what that means is if one was clearly better than another, more money would go into it, bid up it’s price, and then it would be comparably … According to the market place, and the market place is pretty smart. In order to be successful, and being tactical you have to better than the market place. And that isn’t easy.
Therefore the market place is pretty smart. That all of those assets are going to have roughly speaking, comparable expected returns. Other than the surprises that will take place in the future, and you have a choice. You’re either gonna be smart enough, that you think you’re gonna bet against somebody else. That they’re gonna go up or down, or you’re gonna diversify. So, you can take these assets, and achieve a level of balance with those assets. That doesn’t cost you in expected return, but provides you a much lower level of risk.
And if you can reduce your risk, and keep your expected return the same, you gotta do that. So diversification as we were talking about before, can allow an individual … I explained in that book, by the way it’s a great book. ‘Cause what Tony did was to take concepts, and make them very clearly conveyed for the average reader. I explained, and he interviewed me in the book, how to achieve that kind of balance. So that you’re not gonna have that.
Because if you lose 50, or 75 percent of your money in a decline. Let’s say 50 percent, that means you need a hundred percent return to get back-
Right to where you started, yeah.
So you can’t allow yourself to do that. That’s the risk of ruin thing. So diversification, proper diversification can reduce your risk, without reducing your return.
There are many different ways to diversify. How would your approach differ most, if it does from say a David Swenson?
My approach as I was describing it, is to balance the risks based on the two factors that we were … The two determinates that we talked about before, what are the intrinsic drivers of those. And then also what are the timeless, and universal correlations of those assets. And to achieve balance. I’m always looking for a value added, risk-reducing trade. The issue it to look at the intrinsic characteristics, and achieve balance.
Where diversification can get very tricky in the world of say startup investing. You mentioned in brief this lockup period is where someone … I mean, perfect example of this … Has made investments that are liquid for a period of god knows how long– seven to 12 years in some cases– and what started off as a plan to have say 10 percent of ones liquid net worth invested into startups, suddenly becomes 80 percent of the pie chart.
I think … Are you saying, if you have an 80 percent of your portfolio concentrated in the one particular asset?
I would urge you to find out how you’re gonna hedge that thing.
And there are different ways that you can make that hedge. To some extent it’s to buy something, but to some extent you might go into a contract … It could be done almost … I don’t know the nature of the particular types of investments, but if it’s a particular company, with a particular profile that’ll be unique to it. The only way that you’re gonna be able to hedge that, is to go into some probably investment bank, and actually explain to them their circumstances. And find out a structure that they might be able to come across.
It’s gonna be a highly impure hedge, and it needs to be engineered. So it’s a very difficult thing, and because 80 percent of your net worth is tied up, you can’t go have the cash and go buy something that’s going to balance it. And you wouldn’t want to borrow, and then borrow the cash to buy something different. Because, probably it’s correlation with whatever you’re using as a diversifier is not gonna be reliable, and so you could really get screwed. So, I don’t know that I have a good answer for that.
Yeah, it’s a tough one, because like you said, looking because I don’t have anywhere close to the cash required to say, take a sort of derivative position to try to hedge. It is very challenging, and like you also observed, the impure nature of trying to do any kind of secondary with a forward looking promissory note, or something like that. In any case, I don’t want to bore people to tears, but it’s a very common problem in Silicon Valley.
It’s difficult because it’s also a illiquid. So much money is a illiquid. So people can be real rich on paper, but pretty poor cash wise.
I mentioned tactical and psychological. So in a situation like this, where you can’t … There is no magic answer. There is no necessarily non obvious solution to this. It’s just a tough position to be in. Where you stand to potentially lose a lot. What do you say to yourself? What’s your self talk in a situation like that, where you may just be stuck in a position? Or that you can’t get out of. From an investing perspective.
Well I think of, “How bad am I gonna get hurt?” Kinda thing. And I almost think in portfolios sometimes. That it’s better to take a portfolio when you have a certain amount of cash. And you think, “How bad am I gonna get?” And then you could take your risk, and put it in another portfolio. And separate the portfolios, rather than to blend them together so that you’re actually thinking, “Okay how bad is it gonna get?” And also, “Okay so, it’s the nature of the beast.” And, “What’s the big deal?” I mean, you’re going to … When it comes down to it, you’re gonna have a … What can they take away from you?
You’re gonna have a bed to sleep in. You’re going to have food. You’re going to have friends. The most basic good things, you’re playing the game, and it’s the nature of the beast. So I guess that’s … For me, it’s like I keep thinking, “What are they gonna take away from me? And what’s it really gonna mean?”
Have you ever … I’ve read for instances this book titled More Money Than God, which I read a few years ago. And there were a number of cases in that book of very, over the long term, successful investors who had hit a point of overwhelm. Or such high levels of stress that they, based on my recollections, which could be faulty … But effectively hit the reset button. They liquidated all their positions, and kind of started over. Is that something you’ve ever done? And if so, how did you think about that?
No, I’ve never done it because of stress. I’ve liquidated positions to take risk off the table, because certain things have happened, and I’d say, “Listen, I just don’t know, and I’d rather now take risk off the table.” But I do know of one terrific investor who got into a very bad mindset. I mean he just couldn’t make anything work for a period of time. And that started to affect his psychology, that worsened his decision making.
And what he did was he brought his positions down to such a small level. That he was continuing to play the game, but with amounts that wouldn’t have that psychological effect, until he could get back into that mindset, and get back into the groove.
Did that work for him?
That worked for him. Psychology is a big deal. Psychology’s a big deal in the markets. That’s why I also find that my rule based algorithmic type of trading, and rule meaning I take a rule, decision rule. So it’s not a … It’s just the algorithm is just an expression of my criteria. And then I put it into an algorithm. But by knowing how that algorithm works, and having it operate next to me.
In other words I’m doing my decision making in my way, and then all my thinking is programmed into the computer, so that there is a parallel decision making going on, by the computer. Has been fabulous, because that computer ain’t got no emotions. And it’s just like, I don’t know, a computer chess game, and it’s great. And it’s been a fabulous experience to have me, and it playing the game together. So, the taking the emotions out of it, is a real, real plus.
And I’m a meditator, so I would say, “I don’t get as emotional as some people do.” But when you go through it, because you go through a process in which you’re thinking let’s say, something’s going against you. And of course trades will always go against you. It’s not like you buy something, and from that point forward it goes up. That you then sell it, and …
I meant there’s … It’s not like that. And so, if you buy something that’s good value, it might go down before it goes up. And then when you’re wrestling with, “Okay, now do I sell it?” It’s not like that’s the moment either. So, now all, every moment you don’t know whether you’re … Are you missing something? Or are you wrong? Or is it just to early?
All of that psychology enters into it, and you start to think about multiple possibilities, and then, “Okay there’s more opportunity.” That’s why the strategies I’m describing, the combination of diversification, so no one bad bet is gonna matter so much. So I have the casino of bets. So yeah, if I’m wrong I’m on one or here, it’s okay, but that casino means all my games on balance are gonna pay off. And then that notion of systemizing the decision rules. These things have been very helpful to me.
And I think this is a great place to wrap up, and I think it’s … I’m just gonna read a small piece from your book, which I highly recommend everybody check out. I mean, just to give everybody an idea, one of the testimonials blurbs on the book is from Bill Gates, “Ray Dolio has provided me with invaluable guidance and insights that are now available to you in principles.”
So I think that this is gonna do a lot of good in the world, and help people to make better decisions. And here’s a quick quote so, “Everyday each of us is faced with a blizzard of situations we must respond to. Without principles, we would be forced to react to all things life throws at us individually, as if we were experiencing each of them for the first time. If instead we classify these situations in types, and have good principles for dealing with them, we will make better decision more quickly, and have better lives as a result.” And I’m very excited to see what this book does in the world. And I suppose just as one of the very last questions, why did you decide to put this book out? Why now?
I’m at a stage in my life where my objective is no longer to be more successful myself. I’m in a transition. I’m 68 years old, and I felt that my number one goal is to help people be successful without me. And having this collection of recipes that it’s been built up over that period of time, and passing it along. So that basically everything that I know is of value in the book, frees me of that responsibility. And it is what I feel is a sense of responsibility. And I hope everybody … I wish everybody would do that same.
Like I’d love to know … How many peoples principles would you love to know? By the way, I’ve been speaking to a number of, I won’t use the names, but a number of very successful people. And I know now that they are going to be more inclined to put their recipes out. And I think it’ll be fabulous. You should write your principles, how you do share your principles in many ways.
But as those recipes, and you give these recipe books, and people then can compare one to another, and debate them in operating at that principle level I think, is a responsibility that I have to do. And it kind of frees me up to go to my next stage of life.
Well I’ve been taking notes throughout this entire conversation. I’m going to simulate my own pain button, and I have a number of homework assignments that I’m looking forward to tackling. And for people listening, they can certainly learn a lot about the book, and dig in at principles.com. They can find you on Twitter and elsewhere @raydalio. Is there anything else you would like to suggest, or ask, or encourage people to do, before we wrap this up?
No just have their own principles that they believe in, and be open minded. Write their principles down. Compare them with others. Be guided by principles. Be a principle person. I would say that those things probably will help them be not only more successful, but comfortable with themselves.
Perfect. Well, Ray, I really appreciate all the time. This has been a lot of fun for me, and I’ve been looking forward to this every since we met. And you’re so kind, after bolstering my confidence after my rehearsal at TED. So, I really appreciate all of it, and the work that you do.
You nailed it. It was great. We were both nervous that we were going to do a lousy job, and we both got through it well. So anyway, thank you also for your very interesting questions, and the wonderful exchange. Thank you.
My pleasure entirely, and for everyone listening, links to the book, to Ray’s video explaining the economy … Everything that we talked about can be found in the show notes. I will link to everything at tim.blog/podcast, where you can find the show notes for this episode, and every other. And until next time, thank you for listening.