Diversifying Well Is The Most Important Thing You Need To Do In Order To Invest Well

Aug. 13, 2019 7:29 AM ET20 Comments
Ray Dalio profile picture
Ray Dalio


  • It's very hard to make money in the markets for the same reason that it's hard to make winning bets at the racetrack.
  • Diversification can improve your expected return-risk ratio by more than anything else you can do.
  • Excellent diversification with rebalancing to the desired diversified mix both reduces risk and raises expected returns.

One of my most overarching principles is "knowing how to deal well with what you don't know is much more important than anything you know."

Related to this is my fundamental investment principle that "diversifying well is the most important thing you need to do in order to invest well."

This is true because 1) in the markets, that which is unknown is much greater than that which can be known (relative to what is already discounted in the markets), and 2) diversification can improve your expected return-to-risk ratio by more than anything else you can do.

It's very hard to make money in the markets for the same reason that it's hard to make winning bets at the racetrack: because the unknowns are so large in relation to what is "discounted" or "priced in." 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. The hard part is converting this knowledge into winning bets because of how the payoffs reflect what is known. The process of betting will change the expected payoffs so that betting on the worst horse in a race has about the same expected value (i.e., likelihood of winning times size of reward) as betting on the best one-and betting on the worst companies will be equally likely to pay off as betting on the best ones. As a result, most everything is about an equally good/bad bet.

Said another way: 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

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Ray Dalio profile picture
Ray Dalio is the Chairman and co-Chief Investment Officer of Bridgewater Associates, which is a global macro investment firm and is the world’s largest hedge fund. He is known to have a very practical understanding of economics that is very different from conventional economic thinking and that he spelled out in "How the Economic Machine Works". He started Bridgewater in 1975 out of a two bedroom apartment in New York City and has been a global macro investor for more than 45 years. While at Bridgewater his industry-changing approaches to investing -- which include the invention of risk parity, currency overlay, portable alpha and global inflation indexed bond management -- prompted Alternative Investment CIO to write an article entitled “Is Ray Dalio the Steve Jobs of Investing?”, which compared his industry-changing inventions to those of the Apple founder. According to an industry study, Bridgewater's hedge fund has made more money for its investors than any other hedge fund ever -- an estimated $37 billion. Bridgewater Associates has received numerous awards, including over twenty “Manager of the Year” awards from every major financial publication, and Ray has received three “Lifetime Achievement” awards. Additionally, a long list of economic policy makers actively seek his advice, which prompted Time Magazine in 2012 to name him “One of the 100 Most Influential People in the World”. Ray is an active philanthropist with a particular interest in oceanographic research and conservation. He is a participant in The Giving Pledge, a commitment to give more than half of his wealth to charity. Ray believes that reality works like a machine and that principles for dealing with reality are required to be successful. For those who are interested in learning the principles that led to Ray's success, he set them out in Principles.org which focuses on management principles and EconomicPrinciples.org which describes the principles of the economic machine.

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