Ray Dalio — the founder and cochief investment officer of Bridgewater Associates, the world’s largest hedge fund — thinks “diversifying well is the most important thing you need to do in order to invest well.”
He develops his thesis around a focus on the unknown and the return-to-risk ratio.
Dalio provides 10 eye-opening charts that show the power of diversification compared to an array of other assets and sectors.
Click here for more BI Prime stories.
Chances are you’ve heard the old “don’t put all your eggs in one basket” adage a few hundred times by now.
But when a self-made billionaire investor offers an unsolicited take on the matter, it’s best that a market participant leans in with intention.
That billionaire investor is Ray Dalio, founder and cochief investment officer of Bridgewater Associates. And he’s touting diversification as “the most important thing” an investor can embrace.
“Diversifying well is the most important thing you need to do in order to invest well,” Dalio stated in a recent LinkedIn post, echoing one of his most fundamental investment principles.
He backs up his thesis with two main arguments: (1) the unknown is much greater than the known, and (2) diversification can boost your return-to-risk ratio more than anything else.
First, let’s tackle the unknown.
“Just as it’s pretty easy to pick good horses that will likely outperform bad ones at the racetrack, it’s pretty easy to pick good companies that will likely do better than poor ones in a market,” he stated. “The hard part is converting this knowledge into winning bets because of how the payoffs reflect what is known.”
This is an interesting analogy, but one that is definitely apropos.
The stock market is a discounting mechanism. That means that all available information, both present and future, is incorporated into it’s value. It rapidly adjusts to changing circumstances, just like the betting at a racetrack. The market is discounting and pricing in different unknowns perpetually.
Dalio sums up this idea perfectly:
“All investments compete with each other, a lot of smart investors are trying to pick the winners (which changes the pricing that determines what you will win relative to what you will lose in various outcomes) and the uncertainties of what will transpire are large relative to what is ‘discounted’ or ‘priced in,” he stated.
Dalio added: “This means that there are no easy good or bad bets in the markets, and that one’s starting point should be that all investments are roughly equally good.”
In short, the unknowns that are currently “priced in” are most likely going to be much different than what actually transpires.
Next, the return-to-risk ratio.
“Diversification can improve your expected return-risk ratio by more than anything else you can do,” he stated. “Diversifying well is a matter of knowing how to reduce your expected risk by more than you reduce your expected return.”
The return-to-risk ratio aims to quantify the amount of pain an investor can endure for potential gains. For context, a simple demonstration would be an investor that’s willing to lose 10% in order …read more
Source:: Business Insider