Ray Dalio’s Rules for Managing Market Stress

The philosophy explained

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

While no one knows when a recession will strike, economic downturns are inevitable. You can’t wish away 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 this translates to investing

Preparing for market downturns can help minimize your risk. For instance, you should assess what would happen to your finances if your stock portfolio dropped by 20% or 30%. Can you lean on cash reserves and other assets to get you through that rough patch? Some investors put everything into stocks and then find themselves selling equities at low prices to keep up with living expenses.

That’s why it’s important to maintain an adequate cash reserve. Financial advisors tend to recommend an emergency fund that will cover three to six months’ worth of expenses, with retirees bumping that figure to one to two years’ worth of expenses. Investors can also establish guardrails around how much they will withdraw from their portfolios and if they will cut their expenses during market downturns.

Dalio is also a strong advocate for having a well-diversified portfolio. The exact allocation — and whether it goes beyond the traditional makeup of stocks, bonds and cash — should depend on your specific goals, risk tolerance and time horizon. Precious metals, for instance, can be good additions as they tend to not be correlated with the stock market and can rally during periods of economic uncertainty. Though many advisors suggest not allocating more than 5-10% of your portfolio to precious metals.

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Dalio also recommends not trying to time the market and not letting your emotions drive your decisions. Knowing how to manage volatility and corrections lets you operate by logic instead of making emotional decisions. Being fearful about your nest egg and wondering if it will last your lifetime can lead to poor 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. All of the preparation can still result in your portfolio dropping by 10%, but it’s important to keep in mind that ups and downs in the market are normal. You can view market corrections as learning opportunities that let you improve your portfolio’s construction so it can withstand future turbulence.

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Simple steps to get started

There are simple steps you can take to implement Dalio’s philosophies and help protect your portfolio. Start with maintaining a long-term view and setting a regular cadence to review your portfolio and make sure the asset allocation is still in line with your strategy. This frequency lets you stay on top of your asset allocation without turning yourself into an active day trader.

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

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