Ray Dalio’s Rules for Managing Market Stress

Philosophy explained

Dalio’s philosophy involves seeing the world as it is instead of how you want it to be. Although he may be afraid of crashes, learning from them and preparing for the next one is key.

Although no one knows when a recession will hit, recession is inevitable. You can’t wish for a recession, but you can prepare for it. Dalio’s solution is to build a system that anticipates setbacks instead of reacting to them.

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How does this translate to investing

Preparing for market downturns can help reduce your risk. For example, you should evaluate what will happen to your finances if your stock portfolio drops by 20% or 30%. Can you rely on savings and other assets to get you through that rough patch? Some investors put everything in stocks and find themselves selling equities at low prices to keep up with the cost of living.

That’s why it’s important to keep enough money in savings. Financial advisors often recommend an emergency fund that will cover three to six months’ worth of expenses, with retirees increasing that number to one to two years’ worth of expenses. Investors can also establish guidelines for how much to withdraw from their portfolios and whether to reduce their expenses during market downturns.

Dalio is also a strong advocate of having a diversified portfolio. The exact allocation — and whether it goes beyond stocks, bonds and cash — should depend on your specific goals, risk tolerance and time horizon. Precious metals, for example, can be good additions as they tend to be uncorrelated with the stock market and can rally during times of economic uncertainty. Although many advisors suggest that you don’t put more than 5-10% of your portfolio in precious metals.

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Dalio also recommends not trying to time the market and not letting your emotions drive your decisions. Being able to handle change and adjustment allows you to act rationally instead of making emotional decisions. Fearing about your nest egg and wondering if it will last you a lifetime can lead to bad decisions that set you back on your financial journey.

No matter how much you prepare for corrections and drawdowns, they will still happen and affect your portfolio. Every arrangement can still result in your portfolio going down 10%, but it’s important to remember that ups and downs in the market are normal. You can view market corrections as learning opportunities that allow you to improve your portfolio construction to withstand future turbulence.

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Simple steps to get started

There are simple steps you can take to apply Dalio’s philosophies and help protect your portfolio. Start by keeping a long-term view and set a regular cadence to review your portfolio and make sure your asset allocation is still in line with your strategy. This usually allows you to stay on top of your stock allocation without pretending to be an active day trader.

You can also use “what-if” scenarios, such as what your financial situation would look like if the stock market dropped 20%. Meeting with professional financial advisors to do this can remove the emotional aspect of investing and help you focus on making rules-based decisions instead.

Investors can further distance themselves from making emotional decisions based on headlines by enabling automatic contributions. That way, you can go about your daily life while your assets are changing behind the scenes.