A reader asks:
Ben, in your writings you tend to lean to the hopeful and positive side of the future, at least it seems. Then you have folks like Ray Dalio & many other respectable figures who are much more cautious on the future and what it will look like…potential destruction and chaos…ie widening wealth gaps, civil unrest, debt, populism, rising & declining powers… I’m curious if you have these thoughts and worries like Ray does or if you aren’t generally too concerned. Would be an interesting blog post…Some of the things that keep you up at night.
I do consider myself a glass-is-half-full kind of person. I think I was just born this way. I do have plenty of worries but I have a huge amount of faith in the power of the human spirit to figure things out.
I have friends and family members who are more glass-is-half-empty and most of the time it seems like they don’t even realize they lean negative or pessimistic most of the time. It’s a personality trait.
Optimism pays when it comes to investing because, most of the time, markets go up. The stock market is up roughly 3 out of every 4 years, on average. Over the long-term, optimism as a strategy is nearly impossible to beat. This is why buy and hold is perhaps the greatest strategy ever invented.
Unfortunately, there are always good reasons to be worried. The future is always uncertain. There is always bad news and we hear about that bad news more than any generation in history in the information age.
And there is something about finance people that makes them worry more about the downside than the upside. It’s like the exact opposite of people in Silicon Valley who are almost unanimously optimistic about the future.1
Ray Dalio may be right to worry about the future. But he has a long track record of worrying about the future that hasn’t really panned out that well.
Dalio penned a piece for Institutional Investor about the importance of knowing when you’re wrong and changing your mind. He used his own prediction of a depression in the early-1980s as an example:
The biggest of these mistakes occurred in 1981–’82, when I became convinced that the U.S. economy was about to fall into a depression. My research had led me to believe that, with the Federal Reserve’s tight money policy and lots of debt outstanding, there would be a global wave of debt defaults, and if the Fed tried to handle it by printing money, inflation would accelerate. I was so certain that a depression was coming that I proclaimed it in newspaper columns, on TV, even in testimony to Congress. When Mexico defaulted on its debt in August 1982, I was sure I was right. Boy, was I wrong. What I’d considered improbable was exactly what happened: Fed chairman Paul Volcker’s move to lower interest rates and make money and credit available helped jump-start a bull market in stocks and the U.S. economy’s greatest ever noninflationary growth period.
Of course, there was no depression. Instead, the early-1980s kicked off one of the longest expansions in market and economic history.
That history bled into the 1990s as well. It may not seem like it when you look back at high double-digit returns from 1980-1999 but the nirvana-like economic and market environment in the 1990s was not a foregone conclusion at the outset of the decade.
In a piece from the New York Magazine in 1992, Dalio was quoted saying bonds were a better bet than stocks over the course of the 1990s:
Over the long term, both Dalio and Jones agree, as a result of these circumstances bonds in the nineties will almost certainly outperform stocks. In the fifties, says Dalio, wary investors were still looking in the rearview mirror at the Depression of the thirties, when stocks took the shellacking of all time. Thus, bonds remained the preferred investment when the environment of accelerating growth and inflation actually favored stocks. As a result, those who took what appeared to be a risk and bought stocks in the fifties wound up making fortunes, while those who bought bonds wound up eventually losing their shirts.
Now, says Dalio, the situation is precisely reversed. Investors in the nineties remain traumatized over the carnage that inflation and sky-high interest rates wreaked in the bond market in the seventies, so they’re investing in stocks instead. Unfortunately, says Dalio, the current economic climate of low inflation and historically slow growth means that bonds will actually prove to be the better long-term performers.
To be fair, bonds did perform well in the 1990s. The 10 year treasury returned nearly 67% in total from 1992-1999 or 6.6% per year. That’s pretty good for bonds. But the S&P 500 was up more than 316% or nearly 20% per year from 1992-1999.
Dalio was wrong again.
Then in 2015, Dalio began warning we could see a repeat of the 1937 downturn. This nasty recession and 50% market crash is highly underrated by historical standards because it was sandwiched between the Great Depression and WWII. Dalio made a similar prediction for a 1937 situation in 2017.
Alas, there was no double-dip recession following the Great Financial Crisis. The stock market and the economy were doing just fine until the pandemic hit and now are back on trend.
Now, I’m not pointing out Dalio’s mistakes here to rub it in his face. We all get stuff wrong when it comes to the markets. This stuff is hard.
What’s remarkable is how little any of these predictions have impacted the performance at Dalio’s Bridgewater hedge fund. By some estimates, Bridgewater is the most successful hedge fund of all-time, with net gains to their investors of nearly $47 billion since inception.
How is this possible?
By all accounts, Dalio’s predictions about the future aren’t used to make investment decisions at Bridgewater. Despite having some 1,500 or so employees, Bridgewater mostly manages money in a rules-based approach. Bloomberg’s Matt Levine wrote about this a few years ago:
I joked on Twitter that I never understood how Bridgewater gets any investing done, but of course there’s a computer that does the investing. (“After honing ideas through debate and discussion, Bridgewater employees write trading algorithms that buy and sell investments automatically, with some oversight.”) One stylized model for thinking about Bridgewater is that it is run by the computer with absolute logic and efficiency; in this model, the computer’s main problem is keeping the 1,500 human employees busy so that they don’t interfere with its perfect rationality.
Dalio himself has admitted he mostly stays out of the way of Bridgewater’s quantitative strategy and on the rare times he tweaks their algorithms it’s a mistake. At a conference in 2015, Dalio shared the following with fellow hedge fund manager Bill Ackman:
Dalio continued with the advice that you should write down your method so it can be back-tested, he feels that everything can be analyzed and quantified.
99% of the time he agrees with his quantitative strategy, the 1% of the time when he disagrees with the machine he realizes in retrospect that the machine was right 66% of the time.
I don’t know Ray Dalio personally. Made he’s a happy-go-lucky guy in private. He could be the Bill Belicheck of the hedge fund world.2
However, it seems like many of his public comments are usually filled with warnings, risks or dire predictions. That could be a personality trait. Or maybe that’s simply a hedge fund thing as downside protection is kind of their game.
Whatever the case may be, it appears Dalio doesn’t allow his macro predictions to influence Bridgewater’s investment strategy. Or if he does, it certainly doesn’t show up in their long-term track record.
I’m a huge advocate for default settings as an investor.
You should default your savings rate. Default increases to that savings rate over time. Default your investment choices. Default your bill payments. Automating good decisions ahead of time is one of the most important steps you can take to meaningfully improve your finances.
And when it comes to investing, the most important default by far is optimism.
Yes, there are always going to be risks but pessimism does not pay as a strategy over the long-run.
If you’re not optimistic about the future, what’s the point of investing in the first place?
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1Which is probably one of the reasons the tech sector has done so well over the past decade or so.
2Belicheck is a notorious curmudgeon with the media but supposedly has a wicked sense of humor in private.
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