MONEY Master the Game: 7 Simple Steps to Financial Freedom (58 page)

CHILDREN AND CHARITY

With incredible success managing the Pure Alpha strategy, Ray has built up quite a sizeable personal nest egg. Back in the mid-’90s, he began to think about his legacy and the funds he wanted to leave behind, but he wondered, “What type of portfolio would I use if I wasn’t around to actively manage the money any longer?” What type of portfolio would outlive his own decision making and continue to support his children and philanthropic efforts decades from now?

Ray knew that conventional wisdom and conventional portfolio management would leave him in the hands of a model that continually shows that it can’t survive when times get tough. So he began to explore whether or not he could put together a portfolio—an asset allocation—that would do well in any economic environment in the future. Whether it’s another brutal winter like 2008, a depression, a recession, or so on. Because nobody knows what will happen five years from now, let alone 20 or 30 years out.

The results?

A completely new way to look at asset allocation. A new set of rules. And
only after the portfolio had been tested all the way back to 1925, and only after it produced stellar results for Ray’s personal family trust, in a variety of economic conditions, did he begin to offer it to a select group. So long as they had the minimum $100 million investment, of course.
The new strategy, known as the
All Weather
strategy, made its public debut in 1996, just four years before a massive market correction put it to the test. It passed with flying colors.

QUESTIONS ARE THE ANSWER

We’ve all heard the maxim “Ask and you shall receive!” But if you ask better questions, you’ll get better answers! It’s the common denominator of all highly successful people. Bill Gates didn’t ask, “How do I build the best
software in the world?” He asked, “How can I create the intelligence [the operating system] that will control all computers?” This distinction is one core reason why Microsoft became not just a successful software company but also the dominant force in computing—still controlling nearly 90% of the world’s personal computer market! However, Gates was slow to master the web because his focus was on what was inside the computer, but the “Google Boys,” Larry Page and Sergey Brin, asked, “How do we organize the entire world’s information and make it accessible and useful?” As a result, they focused on an even more powerful force in technology, life, and business. A higher-level question gave them a higher-level answer and the rewards that come with it. To get results, you can’t just ask the question once, you have to become obsessed with finding its greatest answer(s).

The average person asks questions such as “How do I get by?” or “Why is this happening to me?” Some even ask questions that disempower them, causing their minds to focus on and find roadblocks instead of solutions. Questions like “How come I can never lose weight?” or “Why can’t I ever hang on to my money?” only move them farther down the path of limitation.

I have been obsessed with the question of how do I make things better? How do I help people to significantly improve the quality of their lives now? This focus has driven me for 38 years to find or create strategies and tools that can make an immediate difference. What about you? What question(s) do you ask more than any other?
What do you focus on most often? What’s your life’s obsession? Finding love? Making a difference? Learning? Earning? Pleasing everyone? Avoiding pain? Changing the world? Are you aware of what you focus on most; your primary question in life? Whatever it is, it will shape, mold, and direct your life.
This book answers the question, “What do the most effective investors do to consistently succeed?” What are the decisions and actions of those who start with nothing but manage to create wealth and financial freedom for their families?

In the financial world, Ray Dalio became obsessed with a series of better-quality questions. Questions that led him to ultimately create the All Weather portfolio. It’s the approach you are about to learn here and has the potential to change your financial life for the better forever.

“What kind of investment portfolio would one need to have to be absolutely certain that it would perform well in good times and in bad—across all economic environments?”

This might sound like an obvious question, and, in fact, many “experts” and financial advisors would say that the diversified asset allocation they are using is designed to do just that. But the conventional answer to this question is why so many professionals were down 30% to 50% in 2008. We saw how many target-date funds got slaughtered when they were supposed to be set up to be more conservative as their owners neared retirement age. We saw Lehman Brothers, a 158-year-old bedrock institution, collapse within days. It was a time when most financial advisors were hiding under their desks and dodging client phone calls. One friend of mine joked painfully, “My 401(k) is now a 201(k).” All the fancy software that the industry uses—the “Monte Carlo” simulations that calculate all sorts of potential scenarios in the future—didn’t predict or protect investors from the crash of 1987, the collapse of 2000, the destruction of 2008—the list goes on.

If you remember those days back in 2008, the standard answers were “This just hasn’t happened before,” “We are in uncharted waters,” “It’s different this time.” Ray doesn’t buy those answers
(which is why he predicted the 2008 global financial crisis and made money in 2008).

Make no mistake, what Ray calls “surprises” will always look different from the time before. The Great Depression, the 1973 oil crisis, the rapid inflation of the late ’70s, the British sterling crisis of 1976, Black Monday in 1987, the dot-com bubble of 2000, the housing bust in 2008, the 28% drop in gold prices in 2013—all of these surprises caught most investments professionals
way
off guard. And the next surprise will have them on their heels again. That we can be sure of.

But in 2009, once the smoke had cleared and the market started to bounce back, very few money managers stopped to ask if their conventional approach to asset allocation and risk management might have been wrong to begin with. Many of them dusted themselves off, got back in the selling saddle, and prayed that things would just get back to “normal.”
But remember Ray’s mantra,
“Expect surprises,” and his core operating question, “What
don’t
I know?” It’s not a question of whether or not there will be another crash, it is a question of when.

MARKOWITZ: THE SECRET TO MAXIMIZING RETURNS

Harry Markowitz is known as the father of modern portfolio theory. He explains the fundamental concept behind the work that won him the Nobel Prize. In short, investments in a portfolio should not just be looked at individually, but rather as a group. There is a trade-off for risk and return, so don’t just listen to one instrument, listen to the entire orchestra. And how your investments perform together, how well they are diversified, will ultimately determine your reward. This advice might sound simple now, but in 1952 this thinking was groundbreaking. At some level, this understanding has influenced virtually every portfolio manager from New York to Hong Kong.

Like all great investors, Ray stood on Markowitz’s shoulders, using his core insights as a basis for thinking about the design of any portfolio or asset allocation. But he wanted to take it to another level. He was sure that he could add a couple more key distinctions—pull a couple key levers—and create his own groundbreaking discovery. He took his four decades of investing experience and rounded up his troops to focus their brainpower on this project. Ray literally spent years refining his research until he had arrived at a completely new way to look at asset allocation. The ultimate in maximizing returns and minimizing risk. And his discoveries have given him a new level of competitive advantage—an advantage that will soon become yours.

Up until this book’s publication, Ray’s life-altering, game-changing approach has been for the exclusive benefit of his clients. Governments, pension plans, billionaires—all get the extraordinary investment advantages you are about to learn—through Ray’s All Weather strategy. As I mentioned, it’s where Ray has serious skin in the game. It’s where he invests all of his family and legacy money alongside the “Security Buckets” of the most conservative and sophisticated institutions in the world. Like Ray, I also now invest a portion of my family’s money in this approach, as well as my foundation’s money, because as you’ll begin to see, it has produced results in every economic environment over the last 85 years. From depressions and recessions, to times of inflation or deflation; in good times and in bad, this strategy has found a way to maximize opportunity. Historically it appears to be one of the best approaches possible to achieving my wishes long after I am gone.

GAME DAY

To be able to sit with yet another of the great investment legends of our time was truly a gift. I spent close to 15 hours studying and preparing for my time with Ray, combing over every resource I could get my hands on (which was tough, because he typically avoids media and publicity). I dug up some rare speeches he gave to world leaders at Davos and the Council on Foreign Relations. I watched his interview with Charlie Rose of
60 Minutes
(one of his only major media appearances). I watched his instructional animated video
How the Economic Machine Works—In Thirty Minutes
(
www.economicprinciples.org
). It’s a brilliant video I highly encourage you to watch to really understand how the world economy works. I combed through every white paper and article I could find. I read and highlighted virtually every page of his famous text
Principles,
which covers both his life and management guiding principles. This was an opportunity of a lifetime, and I wasn’t going to walk in without being completely prepared.

What was supposed to be a one-hour interview quickly turned into nearly three. Little did I know Ray was a fan of my work and had been listening to my audio programs for almost 20 years. What an honor! We went deep. We were pitching and catching on everything from investing to how the world economic machine really works. I began with a simple question:
“Is the game still winnable for the individual investor?”

“Yes!” he said emphatically. But you certainly aren’t going to do it listening to your broker buddy. And you certainly aren’t going to do it by trying to time the market.
Timing the market is basically playing poker with the best players in the world who play round the clock with nearly unlimited resources.
There are only so many poker chips on the table. “It’s a zero-sum game.” So to think you are going to take chips from guys like Ray is more than wishful thinking. It’s delusional. “There is a world game going on, and only a handful actually make money, and they make a lot by taking chips from the players who aren’t as good!” As the old saying goes, if you have been at a poker table for a while, and you still don’t know who the sucker is: it’s you!

Ray put the final warning stamp on trying to beat/time the market:
“You don’t want to be in that game!”

“Okay, Ray, so we know we shouldn’t try to beat the best players in the
world. So let me ask you what I have asked every person I have interviewed for this book: If you couldn’t leave any of your financial wealth to your children but only a portfolio, a specific asset allocation with a list of principles to guide them, what would it be?”

Ray sat back, and I could see his hesitancy for a moment. Not because he didn’t want to share, but because we live in an incredibly complex world of risk and opportunity. “Tony, that’s just too complex. It’s very hard for me to convey to the average individual in a short amount of time, and things are constantly changing.” Fair enough. You can’t cram 47 years of experience into a three-hour interview. But I pressed him a bit . . .

“Yeah, I agree, Ray. But you also just told me how the individual investor is not going to succeed by using a traditional wealth manager. So help us understand what we
can
do to succeed. We all know that asset allocation is the most important part of our success, so
what are some of the
principles
that you would use to create maximum reward with minimal risk?”

And that’s when Ray began to open up and share some amazing secrets and insights. His first step was to shatter my “conventional wisdom” and show me that conventional wisdom on what is a “balanced” portfolio is not balanced at all.

The secret of all victory lies in the organization of the nonobvious.

—MARCUS AURELIUS

UNBALANCED

Most advisors (and advertisements) will encourage you to have a “balanced portfolio.” Balance sounds like a good thing, right? Balance tells us that we aren’t taking too much risk. And that our more risky investments are offset by our more conservative ones. But the question lingers:

Why did most conventional balanced portfolios drop 25% to 40% when the bottom fell out of the market?

The conventional balanced portfolios are divided up between 50% stocks and 50% bonds (or maybe 60/40 if you are a bit more aggressive, or 70/30 if you are even more aggressive). But let’s stick with 50/50 for the sake of this example. That would mean if someone has $10,000, he would invest $5,000
in stocks and $5,000 in bonds (or similarly, $100,000 would mean $50,000 in bonds and $50,000 in stocks—you get the idea).

By using this typical balanced approach, we are hoping for three things:

1. We
hope
stocks will do well.

2. We
hope
bonds will do well.

3. We
hope
both don’t go down at the same time when the next crash comes.

It’s hard not to notice that
hope
is the foundation of this typical approach. But insiders like Ray Dalio don’t rely on hope. Hope is not a strategy when it comes to your family’s well-being.