A Surprising Lesson from One of the World’s Most Successful Investors 

Oct 07, 2022

This week we learned that Ray Dalio is stepping down as the head of Bridgewater Associates, the huge and massively successful hedge fund he founded out of his tiny apartment in 1975.

Dalio isn’t exactly a household name. But he’s a legend in the investment world and holds a special place in our hearts here at TradeSmith.

That’s because he was one of the first investors to take a closer look at the shortcomings of traditional investment strategies. And what he discovered greatly influenced our work here at TradeSmith.

As I explained in my series on portfolio thinking early last year, one of his most important contributions was the idea of “risk parity.”

His research showed that the most successful investors don’t allocate their portfolios based on the amount of money invested in each asset or position. Instead, they invest their portfolios based on the amount of money at risk in each asset or position.

This idea is one of the foundations of the TradeSmith approach to investing and a big reason we’ve been able to help so many folks become better investors.

Dalio also identified four primary market environments or “seasons” that move different asset prices. And he combined those ideas of risk parity and seasons to create what he called the “All Weather” strategy.

The idea behind this strategy was both simple and brilliant. As I explained in that previous series: 

If only four primary seasons drive asset performance — yet it’s difficult (if not impossible) to predict when any particular season is likely to arrive — a well-balanced portfolio should be able to perform well in any of them.

Dalio designed the All Weather strategy to do just that. And it has certainly delivered so far. Since its inception in 1996, this strategy has generated close to 10% average annualized returns.

That’s virtually identical to the returns of a conventional 60/40 (60% stocks/40% bonds) portfolio over the same period. But it has done so with roughly half the volatility and significantly smaller drawdowns than the traditional portfolio.

The actual holdings in Dalio’s All Weather portfolio aren’t publicly available. However, several years ago, he shared a simpler, “do it yourself” version of this strategy for individual investors – known as the “All Seasons” portfolio – that has performed similarly well over the long run.

As you may recall, I shared this portfolio – plus a couple of “upgraded” versions for Money Talks readers – in that series as well.

This week’s news got me thinking: How has this approach fared in the bear market this year?

So, I did a little digging. And what I discovered was both shocking and enlightening.

In short, Dalio’s All Weather strategy has performed downright terribly this year.

Now, I did expect the results to be a little disappointing relative to its historical performance.

That’s because this strategy has a higher allocation to bonds than traditional 60/40 or stocks-only portfolios. And bonds have experienced their worst year in history due to surging inflation and a rapid rise in interest rates.

Still, I was surprised by just how badly this strategy has performed.

According to Bloomberg, Bridgewater’s All Weather portfolio was down a whopping 27% year-to-date as of this week.

That compares to losses of “only” 24% year-to-date in a traditional 60/40 portfolio and 22% in stocks alone.

That’s certainly not what most folks would’ve expected from a well-diversified, “safe” portfolio that has performed so well for so long.

On the bright side, I am happy to report that our upgraded TradeSmith versions of the portfolio did a bit better. 

Thanks to their lower allocation to bonds and higher allocation to commodities, they’re down just under 20% year-to-date.

That beats stocks, a 60/40 portfolio, and Dalio’s proprietary All Weather portfolio (though I suspect that would still be little consolation for anyone holding it).

But that isn’t why I mention Dalio here today.

You see, all those results are from a traditional “buy-and-hold” approach.

However, our research here at TradeSmith shows most investors can earn better returns – while taking less risk – by using trailing stop losses. And I told you these portfolios would likely do even better if you combined them with our powerful TradeSmith “smart” trailing stops.

So, I ran a few more backtests to see if that was indeed the case. And this time, I couldn’t help but smile.

It turns out that if you had invested in our TradeSmith upgraded All Seasons portfolios AND used our Health Indicator Stop Loss, you would have lost less than 3.5% this year.

That’s far better than the results you would’ve earned in stocks (-18%) or a 60/40 portfolio (-11%). And it trounces the results of all four buy-and-hold portfolios I mentioned earlier.

I’m grateful for all the wisdom Ray Dalio has given us. TradeSmith literally wouldn’t be here without his research and insights. But I think the most important lesson we can learn from him may be the simplest: 

The markets are unpredictable. Even the world’s smartest and best investors can sometimes get it wrong.

What matters is how much you earn when you’re right and how little you lose when you’re wrong. And trailing stop losses are an easy yet powerful way to shift the odds of success in your favor.

If you aren’t already using trailing stops in your investing, I hope you’ll consider them now.

As always, if you have any questions or comments on today’s editorial – or any previous Money Talks topics – you can reach me directly at [email protected]. I can’t respond to every email, but I read them all.