A macro maestro

Aggressive enough to capitalise on upcycles and diverse enough to survive downcycles - if you boil down the jargon, this might be the investment philosophy of Ray Dalio, one of the greatest investors of our time.

Ray Dalio founded Bridgewater Associates out of his two-bedroom apartment in New York City in 1975 and built it into the largest hedge fund in the world. As of May 2023, the fund had an AUM of $124 billion.

But his contributions to the investing world might just outshine his exploits in the markets. Dalio is the greatest torch-bearer for macro investing, an investment approach that relies on macroeconomic trends to identify investment opportunities and assess risk.

How Ray Dalio uses macroeconomics to reduce risk

He pioneered the investment principle of "risk parity", which, in simple terms, means balancing risks by diversifying across asset classes that are not correlated.

The overall economy is bound to go through upcycles and downcycles. During upcycles, equity and equity-linked asset classes shine. In contrast, fixed-income instruments are better investment vehicles during economic downturns.

Dalio suggests that if you diversify across equity and fixed-income asset classes, your portfolio will race ahead during upcycles thanks to the equity part, and your fixed-income investment will help you minimise the impact of falling markets in a downcycle.

How Dalio learnt the lesson of diversification

In a recent podcast we discovered, Dalio disclosed the first major setbacks that taught him the importance of diversification.

Dalio predicted that after the Mexico debt crisis, the US economy will crash. However, the reverse happened and Bridgewater incurred severe losses and had to fire nearly half its employees. This was the first major setback of Dalio's professional career that taught him why diversification is key to risk control.

Referring to this event, Dalio said the following in the podcast:

"And it made me really learn how to diversify my bets. By diversifying my bets, I could radically reduce my risk without reducing my returns. And it lets me also reflect on life".

Your takeaway

The latter half of this decade was a crash course on how unpredictable the global economy can be. Dalio's risk parity approach is paramount in the present macro backdrop. However, diversification is only part of the puzzle. Regardless of your portfolio-building approach, your investment should be based on your risk tolerance and investment goal. For example, building a portfolio that is heaving on fixed-income instruments might help you during economic downturns, but it is not optimum if your goal is long-term wealth creation.

Also read: Bill Ackman's guide to investing