I recently finished reading Principles: Life and Work by Ray Dalio. It’s an insightful book that teaches me a lot of useful lessons.
Here I’d like to share one of the lessons with you. It’s a principle on how to maximize your upside while minimizing your downside. Interesting, isn’t it?
The principle came from the world of investing. One day, Ray Dalio – who led a successful hedge fund – got an insight that led to a breakthrough in investing. This is how he put it:
That simple chart struck me with the same force I imagine Einstein must have felt when he discovered E = mc2: I saw that with fifteen to twenty good, uncorrelated return streams, I could dramatically reduce my risks without reducing my expected returns… I called it the “Holy Grail of Investing” because it showed the path to making a fortune.
You might think that the statement is an exaggeration, but the results spoke for themselves: his hedge fund is among the best in the industry.
The principle doesn’t just apply to investing, though; you can also apply it to your life. In his words:
The success of this approach taught me a principle that I apply to all parts of my life: Making a handful of good uncorrelated bets that are balanced and leveraged well is the surest way of having a lot of upside without being exposed to unacceptable downside.
What is the lesson? Here it is:
To maximize your upside while minimizing your downside, make good uncorrelated bets in your life.
The keywords here are uncorrelated bets. Let’s look at the two words one by one, starting with the last word.
It’s interesting that Ray Dalio used the word ‘bets’. Why? Because Bill Gates used the same word! It seems that ‘making bets’ is how successful people work. It seems to be their mindset.
What does ‘making bets’ mean?
It means that you take risks; you move out of your comfort zone and embrace uncertainty. You face the possibility of failure but you do it anyway.
Making bets is how you maximize your upside. You take a risk that could give you exponential reward. Though you could fail, you are fine with that. Why? Because the regret of failing is less than the regret of not trying!
Notice that the word ‘bets’ here is plural, not singular. You should make several bets, not just one. Making just one bet isn’t wise because it gives you an unacceptable downside. You put all your eggs in one basket and you could lose them all.
It’s not enough just to make several bets, though. There is one more thing you should do.
‘Making bets’ is how you maximize your upside. But how do you minimize your downside?
Making your bets uncorrelated is how you minimize your downside. It means that when one bet failed, it shouldn’t bring the other bets down with it. The bets should be independent of each other.
How do you implement it?
You implement it by diversifying your life. With your personal finance, you should have some income streams, not just one. With your social life, you should know people from some social groups.
But again, you need to make them uncorrelated. It means that your income streams should be independent of each other. There shouldn’t be a risk that takes them all down at the same time. With your social life, it means that your social groups should consist of different people. If there is something wrong with one group, it shouldn’t affect the other groups.
Take risks but make sure that they are uncorrelated. If you do, you will maximize your upside while minimizing your downside. You will be optimizing your life.
Recommended Book Summary: Principles: Life and Work