Ray Dalio’s BIG Warning of a Lost Decade for Investors (2022-2032)

Nowadays the structure of the markets and where everything is priced, um, if um and done the normal way, we'll give you probably a return in the vicinity of, with a lot of risk around it, uh, maybe in the vicinity of four percent. Okay, three, three and three percent, three, four percent. Okay, something that might not equal inflation, probably it'd be very close. And then you have to pay taxes on it.

Ray Dalio is an investor I follow very closely. Dalio is the founder of Bridgewater Associates, the world's largest hedge fund with 150 billion dollars in assets under management. He recently did an interview where he talked about some important topics that I know you care about: what is happening in the stock market right now, how we as investors should be investing in this crazy market, and finally, what returns on our investments we should expect in the coming years.

Now let's get into the video. As we talked today, uh, the stock market in the last couple of weeks has been correcting, if that's the right verb, and a lot of the error is out of the so-called bubble. Should people be selling everything and getting out of the market now because the markets are going down, or is this the time to buy? Uh, first of all, I'm not here to give a lot of advice, but I'll give you the following thoughts. Um, we won't tell anybody, just give us a summary, okay? Just, just on our own.

Um, what's happened is that they produced a lot of debt and gave out a lot of money, and so everybody's got money. It's also very easy to borrow money to buy things. As a result, if you create much more buying power than you create goods and services, you've got a lot much more inflation. The Federal Reserve has been behind the curve, slower to tighten monetary policy, and as a result, we're now starting to see the rise in interest rates to be able to deal with that.

As that happens, all assets compete with each other. So now that free money is still going to be cheap money, but it's going to be, um, a bit higher. So interest rates, let's say bond yields, have gone up about one percent. Now you take that and you adjust everything as the present value of future cash flows. But it means that that interest rate goes up a percent, that means all the other assets have to adjust. We're in a process of making that kind of adjustment.

That means the days that we've had before, the easy days where they dump money on you and you don't have much inflation and you don't have much time, those are passed. Now we're in a different kind of part of the cycle. One thing that really stood out to me from this clip, and quote Ray Dalio, is the adjustment that is happening to the stock market currently. As interest rates rise, it's a basic principle of finance that the value of any asset, whether it is a stock, an apartment building, farmland, or even a local small business, is based on the cash that business is going to generate over its lifetime, discounted back at a given interest rate.

What is happening right now is that the interest rate that is being used to discount those future cash flows is increasing, which is resulting in a lower present value for assets. I know that is complicated, so let me show you an example. Let's say, in this example, we are valuing a stock in a business that will operate for 10 years, and then at the end of year 10, we will be able to sell that stock for five times its year time cash flow. In year one, each year of stock produces ten dollars in cash flow.

Let's say the business is able to grow the annual cash flow per share by two dollars each year for ten years, resulting in cash flow of twenty-eight dollars per share at the end of year ten. In order to calculate the value of the stock, we have to discount these cash flows back to the present day using a given interest rate. The reason we do this is because a dollar received 10 years from now is not worth as much to an investor as a dollar received in cash today. If I said I was going to give you one thousand dollars in cash today or one thousand dollars in cash 10 years from now, which one would you pick? Of course, you would pick the one thousand dollars today.

This concept is also referred to as the time value of money. Let's have five percent be our discount rate to start with. To calculate the present value of these cash flows, or put another way, the intrinsic value of this stock, we would do a net present value equation. This would get us with the present value, or intrinsic value, of this particular stock of 226 dollars and 47 cents.

Now let's see what happens if we change the interest rate at which we discount the cash flows. If we decrease the interest rate to 4 percent, the intrinsic value of this stock goes up to 243 dollars and 45 cents. If we decrease the interest rate to 3 percent, the intrinsic value again increases to 262 dollars and nine cents. And finally, if we decrease the interest rate that those cash flows are being discounted at all the way to 2 percent, the value of the stock goes up all the way to 282 dollars and 58 cents. Notice how with each percentage point the interest rate decreases, the value of the stock goes up.

Now let's see what happens when the opposite occurs. When we increase the interest rate that we use to discount the cash flows from the stock, now this is a very important part to understand. This is what Ray Dalio is referring to when he talks about the interest rate adjustment going on in the stock market. If we increase the interest rate to 6 percent from the 5 percent we started at, the value of the stock goes down to 226.47, a 7 percent decrease in the value of the stock due to the interest rate increase.

Next, if we raise the interest rate up to 7 percent, the value of the stock goes down to 196 dollars and 84 cents, a 13 percent decrease from the value of the stock at the 5 percent interest rate. And then if we raise it up to 8 percent, the value of the stock falls even further, all the way to one hundred and eighty-three dollars and ninety cents, a nineteen percent fall from the value of the stock at the 5 percent interest rate. This is what is happening in the stock market right now. Even though interest rates haven't yet increased dramatically, investors are worried that interest rates will increase in the future, and as a result, the stock market has declined in value.

To start out this year, it's important that as investors we remember that the value of any stock, or any asset for that matter, is based on three main variables: how much cash that stock will generate for its investors, the timing of those cash flows, and finally, the interest rate at which those cash flows are discounted back to the present day. Right now, that third variable is being adjusted up by investors, and as such, the stock market's perceived value of stocks is decreasing.

Now we will get to this more later in the video, but it's super important to note that Ray Dalio believes in a diversified investment portfolio. Instead of trying to time the market, Dalio says that it should be an investor's goal to build a well-diversified portfolio that will perform well regardless of what happens with the stock market. And this one particular asset class is a great way to diversify your portfolio. I'm talking about physical art. In fact, contemporary art prices outpace the S&P 500 total return by 164% from 1995 to 2021 and has seen almost tripled the appreciation of real estate, gold, and 90% of cryptocurrencies during that same time.

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Now, let's get back into the video. So this brings us to the million-dollar question, or in the case of Ray Dalio, the 150 billion dollar question: what should investors be doing in this market? And maybe even more importantly, what return should investors expect? Ray Dalio's prediction of three to maybe four percent annual returns for investors is a huge difference from what investors have enjoyed over the past decade. Investors since the great financial crisis have regularly enjoyed double-digit annual returns.

Check out the returns on the S&P 500 index since 2011: 2 percent in 2011, 16 percent in 2012, 32 percent in 2013, 14 percent in 2014, 1 percent in 2015, 12 percent in 2016, 22 percent in 2017, negative 4 percent in 2018, 32 percent in 2019, 18 percent in 2020, and 29 percent in 2021. This is a compounded annual return on the S&P 500 of 14.4% from the start of 2011 to the end of 2021, assuming dividends reinvested.

This is one of the best performing periods for the S&P 500 and one of the greatest bull runs in the history of the US stock market. It's a pretty well-publicized statistic that the long-term average return on the US stock market is around 10%, but what is less well-publicized is that the average return has been far from linear. Take a look at the S&P 500. In the year 2000, the S&P 500 briefly crossed 1,500 during the year.

Do you know the next time it hit that level again? Seven years later in 2007, and that was very short-lived. The fallout of the great financial crisis and subsequent collapse of the stock market took the S&P 500 down to less than 800 at some points in 2009. In fact, it would take the S&P 500 until the year 2013 until it was comfortably above 1,500 again for an extended period of time. This means investors that invested at the top of the stock market in the year 2000 did not see their investment break even until 13 long years later.

This means for 13 years, the invested annual return was 0%, not including dividends. If you were to include dividends, that number would likely be around one to two percent. In hindsight, investors from the years 2000 to 2013 would have been happy with the three to four percent returns Ray Dalio is talking about now.

Ray Dalio's future return projections get even less exciting when you factor in the impact of inflation. I don't know if you caught it because it was kind of subtle, but Dalio mentioned that the three to four percent annual return would be just barely enough to break even after inflation. This means that Dalio is projecting inflation will be around three to four percent annually. We, as investors, should be concerned with what is referred to as our real return.

Put simply, this is our return on our investment portfolio minus the inflation rate during the year. Let's say Ray Dalio is right and future returns over the next decade average four percent annually, and let's also assume that Dalio is right about inflation too and the average annual rate of inflation is four percent. This means we take our four percent return and subtract out the inflation rate of four percent, leaving us with a real return of zero percent.

Now this leads us to the most important topic of this video: how can we as investors be positioning our portfolios in order to generate the highest possible return with the lowest amount of risk possible while still lessening the impact of inflation? To answer this question, Ray has two specific pieces of advice. The first piece of advice is don't be sitting on cash. As Dalio says, cash is trash.

With the stock market hovering around all-time highs, it may be tempting to try to time the market. Some investors may be tempted to sell their stocks and hold large amounts of cash and wait until the stock market crashes and then buy at the bottom of the crash. However, Ray Dalio has warned that timing the market is a fool's game. In other words, just because the stock market may be overvalued, that doesn't necessarily mean a crash is right around the corner. In fact, Dalio has been pretty adamant that he believes holding cash is the worst possible investment.

And the reason behind that is that one simple pesky word: inflation. Going back to our earlier example about calculating the real return on your investments after inflation: let's say stocks return only four percent and inflation is also four percent. That means your real return is zero percent. However, if you're holding cash, your return on cash is zero percent, and after subtracting out that four percent inflation rate, your real return on holding cash is negative four percent.

The only thing worse than a zero percent real return is a negative real return. The next piece of advice from Dalio is to diversify your portfolio. Now this topic itself could be its own video, but I wanted to touch briefly on it during this video. Dalio is a big believer in portfolio diversification, or put another way, and to use an old phrase, not putting all of your eggs in one basket.

This means that putting ninety percent of your portfolio in Tesla stock may not be the best approach to investing. Instead, Dalio recommends that an investor should build a portfolio of investments that will perform well in all types of economic environments. While Dalio was constantly watching the market and the economy, he himself admits that he can't predict the future. Thus he suggests a need for a portfolio that mitigates the financial impact of unexpected economic events.

The portfolio that Dalio employs uses a mix of stocks, bonds, gold, and other commodities. So there we have it. It's so great to learn from an investor like Ray Dalio, and as always, thank you guys so much for watching. Make sure to like and subscribe to the channel because it is my goal to make you a better investor by studying the world's greatest investors. Talk to you soon.