Ray Dalio: STOP Trying to Time the Market

Wouldn't it be great if we as investors could know right when the stock market was about to fall so we could get out and not lose money? And then jump right back in at the bottom of the market? Based on some of the videos on YouTube and articles written on the internet, you may actually think this is possible. However, billionaire investor Ray Dalio says it is foolish to try and time the market. Let's listen to what he has to say.

“How do you value this market today?"

“I think that just the way you said it is going to be a fool's journey. To say, here's the stock market and I'm going to time the movement into the market, I'm going to time the movement out of the market. Okay, you know what that means? Okay, you're going to outguess what the next variant move is and what the next other thing is. A lot of things depend on a lot of other things, and the world and everything readjusts.

What has to happen, I think, is investors most importantly have to realize two things. First, that cash is not a safe investment, is not a safe place because it will be taxed by inflation. There will not be an interest rate that will anywhere near compensate, and it seems good because it's not volatile, but you're paying a tax of a few percent a year on that. So stay out of that.

And then, B, know how to balance a portfolio, because the way portfolios work, it's almost like for some part something happens, another thing happens. In other words, what you can see in the markets today is that, let's say when equities go down because growth expectations falter and there's a greater likelihood of easing, then you see the bond market go up. Or when you see other markets, gold, you're seeing.

Watch the market action on every day and you could see those relationships. But wealth is not destroyed as much as it is transferred. And if you know how to balance those investments, we do it in a what we call an all-weather portfolio. But if you know how to balance those investments, that's the most important thing.

Being a safe, well-balanced portfolio, you can reduce your risk without reducing your return. And you will not market time this because even if you were a great market timer, the things that are happening can change the world, so it changes what should be priced into the markets.”

One thing I want to discuss further is the concept of cash not being a safe investment. One of Ray Dalio's most well-known quotes is, “Cash is trash.” However, the concept of cash actually not being a safe investment goes against conventional wisdom. Let me explain what I mean.

If you were to open up a boring, dense finance book, there is generally what is considered a hierarchy of investments based upon the perceived level of risk of each type of investment. As the investments get riskier, the theory goes that the annual return that investors require on their money increases. At the bottom of the hierarchy is cash. This is because while the investment return you would receive on cash is minimal, if anything, you don't have to worry about losing any money because the cash is just sitting in a bank account.

Let's say your return on cash is zero percent a year. Next up in the hierarchy, you have government bonds. For those of you who may not know, a bond is when a government or company borrows money and makes a promise to pay that money back over time with interest. The returns on government bonds are higher than cash but are also considered slightly more risky because the chance of a developed government not paying back its debt is very low, but not entirely zero. Let's say the return on government bonds is three percent a year.

Above government bonds, you have corporate bonds. These corporate bonds are considered more risky than government bonds because the chance of a company failing and not being able to repay its debt is higher than that of the government. It is somewhat common for companies to struggle, fail, and even go out of business. It is a completely normal occurrence that happens even during a healthy economy. Because of this risk, companies have to pay investors more money to be able to borrow money. Let's say the return on corporate bonds is five percent a year.

Next up, we have stocks. Stocks are generally considered more risky than bonds. This is because with stocks, you are considered a part owner of the company. This means that if the company starts to struggle, all the bondholders would be paid back first before the stockholders get a single penny. This is why a lot of times when a company goes bankrupt, the bondholders receive maybe 75 percent of their invested money back, but the stockholders lose their entire investment. Because of this, stocks are considered more risky than bonds. Let's say the return on stocks is 10 percent a year.

At the top of the hierarchy, we have what is considered alternative investments. This category consists of things like real estate, private equity, and venture capital funds. These types of investments typically get grouped together into an umbrella term called alternative investments because they are outside the normal investing landscape of traditional stocks and bonds. Generally, these are considered the most risky investments of all. As a result, let's say the annual return on these investments is 15 percent.

So now that we understand this concept, why does Ray Dalio refer to cash as risky? Didn't I just say cash is the least risky of all investments? The reason why Dalio refers to cash as risky is due to this pesky little thing called inflation. In order to find what is referred to as the real return of an investment, you have to take the return the investment generated that year and subtract out inflation.

So if your investments generated 10 percent in a given year and inflation was 2 percent, that means your real return was 8 percent. Let's revisit that investment hierarchy we talked about earlier. Ray Dalio has been extremely vocal about his thoughts around inflation. He believes higher inflation in the United States is here to stay.

So earlier in the video, I gave example returns for each of the different investments. Now let's factor in inflation to calculate the real returns of each of the investments. Let's say Dalio is right and higher inflation is here to stay, and let's assume the inflation rate is 6 percent in this example. Starting at the top, the real return for alternative investments is 9 percent. The real return for stocks is 4 percent. The real return for corporate bonds is negative 1 percent. The real return on government bonds is negative 3 percent. And finally, the real return on cash is negative 6 percent.

This is why Dalio was saying that cash is risky. If you're just having your cash sitting in a bank account and not producing an investment return for you, inflation is eroding the value of that cash. In order to lessen the impact of inflation, your money needs to be producing a return for you.

So this brings up the important question: if timing the market is ineffective and cash is a bad investment, how exactly should we be investing? Let's listen to what Dalio has to say.

“Cash, I've been quoted, cash is trash. That cash which most investors think is the safest investment is, I think, the worst investment. And that it's important because it loses buying power. The one thing I would say to investors is don't judge anything in your returns or your assets in nominal terms, in terms of how many dollars you have. View it in terms of inflation-adjusted dollars.

And so cash, like this year, you'll lose 4 or 5 percent to inflation. So pay attention to those because I believe that that'll be the worst investment. And then beyond that, the important thing is to diversify one's portfolio well. Because we know from that the surprises and the balance, we also know that those asset classes, on average, significantly outperform and will significantly outperform cash. And that they move between each other in a way that one that has to do with correlations, because of when things go down. When the economy goes down, then bonds will do better than stocks and so on and so forth.

So diversification of assets and the message is cash is going to be a problematic asset.”

Unlike other investors we cover on this channel like Warren Buffett and Charlie Munger, Ray Dalio is a huge supporter of having a diversified 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 regardless of what happens with the stock market.

In fact, Ray Dalio is well known for what is referred to as his all-weather portfolio, consisting of stocks, bonds, and commodities such as gold. The goal of the all-weather portfolio is to generate strong returns regardless of what happens in the economy. That means the portfolio is designed to perform well in inflation or deflation, and whether the economy is growing or shrinking.

Dalio's all-weather portfolio consists of 30 percent stocks, 55 percent bonds, and 15 percent commodities. Now, by no means am I saying go out and copy his portfolio. However, I do think it makes sense for an investor to have a diversified portfolio. What that portfolio consists of depends very much on your age and what investments you understand.

Personally, my own portfolio consists of an S&P 500 index fund, three to five stocks that I have high conviction in, and my investment rental properties. Based upon my age, 24 years old, and my willingness to put in the effort needed to pick individual stocks and invest in real estate, I believe this is the best mix for me to build wealth over the long term.

Something else that wasn't mentioned by Dalio but is still super important when it comes to people trying to jump in and out of the stock market is the tax impact of doing so. Here in the United States, where I am located, investment gains are taxed in two distinct categories. The first is short-term capital gains, which is for investments that are held for less than one year. The second category is long-term capital gains, which is for investments that are held for one year or longer.

Each of these categories are taxed at significantly different rates and are just another reason against trying to time the market. Short-term gains do not enjoy any special tax treatment and are taxed as ordinary income and are subject to a federal tax rate of up to 37 percent. On the other hand, long-term capital gains receive preferential tax treatment. The highest tax rate for long-term capital gains is only 20 percent and you will pay only a tax rate of 15 percent if your income is less than around $400,000.

This means that if you try to consistently jump in and out of the stock market every few months, any gains that you earned will be taxed much more than if you had held those investments for one year. This is a part of investing that rarely gets talked about enough, but is extremely relevant for this topic of investors trying to time the market.

So there we have it. What do you think of Ray Dalio's comments about inflation? Let me know your thoughts in the comments below. Also, make sure to like this video and subscribe to the Investor Center if you aren't already because it is my goal to make you a better investor and build wealth. Thanks for watching, and I'm looking forward to talking to you guys again soon.