Ray Dalio on the power of diversification and risk balancing

The big question for me was what the investment benefits of diversification would be ... How do I know what will be the end result of the whole process. Then I decided to focus my thinking on the word "risk". The appropriate amount of risk and make a correlation between the correlation of risk and the number of transactions to the last. To give it an example, let's say we have to get a return on something that carries a 10% risk. We'll call this the "standard deviation" and say that there is a 10% return.

Suppose it adds another asset, another element of return. So I add the third, fourth, fifth and as long as necessary. How will this action reduce my risk if on average it has a 60% correlation with assets, or 40% or 20% or 0%? Imagine having a 10% return, but you don't know which asset will perform better. Your average return is 10% with 10% risk, where you add second, third, etc. assets. However, you will not lose that 10% return. Only your level of risk will be reduced. At 60% correlation and three or four assets, you will get a reduction of about 15% and even if you add another thousand assets, at 60% correlation you will not be reduced by so much risk.

Now, as we look at how the risk changes according to the level of correlation, I will start to think what would happen if I added an asset with a 10% correlation. So in the presence of 7 or 8 assets, I cut my risk by half and double my return based on my risk. This way, we understand how strong the diversification is in terms of the assets I will seek.

For me, the magic here is if you can find 15 or 20 yields that are not correlated. Assets most likely to make money (you don't know this, of course). However, they are likely to generate you money and are poorly correlated. This is exactly what I'm going to pursue. That's the key. Many people think that the most important thing they need to do is find the best investment.

But there is no single good investment to compete with this diversification model. When your risk is reduced, you can improve your return-to-risk ratio by up to five times. You will never find such a good sole investment. This is the power of risk balancing and diversification. This diversification also reduces the likelihood of bankruptcy after a year, for example. This is the power of building a portfolio.

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