The World's Most Powerful Hedge Fund Manager Tells Investors How They Should Set Up Their Portfolios

Hedge fund god Ray Dalio, who runs Bridgewater Associates, is widely considered to be the most successful hedge fund manager in the world.

He recently sat down with CNBC's Maria Bartiromo to discuss a variety of topics at the Council on Foreign Relations and he had some advice for the average investor. 

During the hour-long discussion, Bartiromo asked Dalio about portfolio allocation in terms of gold versus equity versus real estate and other asset classes.

Here's his advice that we've transcribed: (emphasis ours) 

First, Dalio explains what you need to think about when setting up a portfolio.  The key here is asset allocation. 

"So I think I'm going to answer it in the following way that I think that is the right way for people to look at it. It's the way I look at it. I think that the first thing is you should have a strategic asset allocation mix that assumes that you don't know what the future is going to hold.  And I think most people should..." 

In other words, if you're thinking of "beating" the market, as though it's a game, you're probably going to lose.

"In other words, let's say, I play the game of betting against others. So it's like I'm going on the poker table and if I'm smarter, and I know how difficult that game is, so very few winners.  And like if I'm not engrossed in it and if we're not engrossed in it, I'd be worrying about it and I do worry about it when I am engrossed in it.  So the average investor and most people should not be playing that game.  They're going to lose at the poker table."

This is why Dalio emphasizes the importance of a balanced portfolio, especially in terms of risk.  

"So what that means, they should have a properly balanced portfolio.  Now the most important thing is that is that they balance... They make a mistake in terms of dollars invested and with a bias with what's done well in the past and they don't realize that risk.  They should balance it in terms of risk.  

"Let's say stocks have twice the volatility, more than twice the volatility, of bonds and when they own a portfolio and structure a portfolio that way they tend to have concentrated risks. And I think what they need to do.  I would recommend reading, read, on the subject of risk parity, read on our website, we have an explanation on how to balance risk, but they key thing is that there are basically four economic environments.  There are two main drivers of asset class returns-- inflation and growth." 

Here simplifies how inflation and growth affect the prices of asset classes based. 

"Assets all price based on, you could look at the pricing of asset classes and calculate what the discounted growth rate is and what the discounted inflation rate is. And what causes assets to move is surprises to that.  So when growth is faster-than-expected, stocks go up.  When growth is slower-than-expected, stocks go down.  When inflation is higher-than-expected, bonds go down.  When inflation is lower-than-expected, bonds go up.  OK. 

Dalio says it's important for the average investor to understand inflation and growth and their effects.  That's why he suggests having four different portfolios to achieve balance.  

"What I'm trying to say is that for the average investor, what I would encourage them to do is to understand that there's inflation and growth. It can go higher and lower and to have four different portfolios essentially that make up your entire portfolio that gets you balanced.  Because in every generation, there is some period of time, there's a ruinous asset class, that will destroy wealth and you don't know which one that will be in your life time. So the best thing you can do is have a portfolio that is immune, that is well diversified.  That is what we call an all-weather portfolio.  That means you don't have a concentration in that asset class that's going to annihilate you and you don't know which one it is...

Again, the reason you should have a balanced portfolio is you don't know what the future holds, says Dalio.  

"Well, I'm saying based on the notion that you don't know which one it is. And therefore,..when you say 'which should it be today?' It should be balanced today like it is in the future and it should have that mix of assets.  And now you get into a whole conversation...But you need to achieve balance..."

From businessinsider.com