Ray Dalio: As AI Giants Dominate the U.S. Stock Market, I Choose Not to Bet on Direction, But Do One Thing

Original Title: Investment Principles: What Should You Do Under Existing Conditions?

Original Author: Ray Dalio, founder of Bridgewater Associates

Original Translation: Peggy, BlockBeats

Editor's Note: As AI giants continue to push US stock indexes higher and market concentration rises, Ray Dalio revisits a classic question in his latest note: When a revolutionary technology is changing the world, how should investors allocate their assets?

Dalio's core reminder is that technological progress itself does not make related stocks equally attractive. Major technology cycles throughout history have typically experienced phases of excitement, crowding, volatility, and shakeout. Even long-term winners like Microsoft and Apple have suffered significant drawdowns during these cycles. Today's AI industry faces multiple uncertainties, including overinvestment, intensified competition, geopolitics, tax policies, anti-AI sentiment, and disruption from next-generation technologies.

The most important takeaway of the article is not about judging whether AI will change the world, but rather discussing how investors should navigate a "highly concentrated" market structure. Dalio argues that when a handful of tech companies account for an increasingly large share of an index, investors need to be wary of unconsciously holding highly correlated, high-risk concentrated exposure. Instead of continuing to chase a few leaders, a truly more prudent approach is to build a diversified portfolio of high-quality, low-correlation assets and adjust volatility levels according to one's own risk tolerance.

In his view, knowing what you don't know is just as important as knowing what you do know. Facing the current market environment—driven by AI, with elevated valuations and concentrated risk—investors should not directly translate their excitement about new technologies into concentrated holdings of a few AI stocks. Diversification, in Dalio's eyes, is the "Holy Grail of Investing" for navigating this technology cycle.

The following is the original text:

This note discusses how one should play the investment game in the current environment.

Imagine you are playing a game like bridge, poker, backgammon, or chess. It's your turn, and you have a computer by your side that can assess the situation with you and suggest next moves. For me, the investment game is exactly like this. Whether or not you have a computer to assist, I believe you should:

Ask yourself what the next move should be based on the current state of the board. That is, decide how to act based on the existing characteristics of the market and the various forces affecting it.

I have been playing the investment game for a very long time. At this stage, my goal is to pass on how I would play the game; further, I hope to create a platform where various people can explore the investment game in their own way, learn, backtest how they would have done in the past, and truly do it well. I believe there are right and wrong ways to play the hand you are dealt. Therefore, when you encounter a specific combination of conditions like XYZ, you should ask yourself: "Given this situation, how should I bet?" And be able to give a good answer.

Now, I want to share with you what I see as the current market characteristics, what I think should be done, and what I am actually doing.

How to Deal with the Current Set of Conditions

What are the most important environmental factors right now? Under these factors, how should one bet?

In my view, and likely in the view of most, the current market environment is one where a few companies dominate market movements, driven by a major new technology, primarily AI. These companies account for a very high percentage of total market capitalization and are having a massive impact on markets and economies. All such periods share a common feature: significant excitement, uncertainty, and volatility concentrated in the new technology sector, transmitted to global stock markets through this sector. Therefore, the volatility and uncertainty surrounding this sector are very important.

Beyond this, there are uncertainties related to other major forces. I call these forces the "Five Forces": 1) What is happening with debt and money; 2) What is happening with political and social issues that could significantly impact taxes and other politically driven market factors; 3) What influence geopolitical factors, such as wars, have on markets; 4) What is happening with natural forces; 5) What is happening with new technologies. I input these conditions into my investment system to consider how to bet in this environment, while also thinking independently about what to bet on.

When thinking about how to bet in this environment, the most important question is: Which choice do you really want to make? a) Bet more heavily on new technologies compared to a broad-based stock index like the S&P 500, i.e., overweight this new sector, or overweight the few companies you believe are the best in this sector; b) Keep your exposure roughly around the index weight; or c) Diversify away from this concentration?

Almost everyone wants to buy the best investments and will work hard to do so. Right now, a new technology appears that seems to change almost everything. But history shows that at this stage of the cycle, most people fail because they put a very large proportion of their chips on a few leading technology stocks. There are logical reasons for this, and it has always evolved this way in the past. While this AI technology is indeed unique, there have been many similarly "unique" new technologies in history that can serve as analogies and references. People should study these cases; if they choose to ignore them, they must be able to explain well why this time is different.

The Risks Are Undoubtedly High

All past cases of major new technologies have unfolded in similar ways due to the same logical reasons. High risk and massive uncertainty are inherent characteristics of these new technology companies. Looking back at the performance of such companies in similar historical environments, even the best revolutionary new technology companies that thrived long-term, like Microsoft and Apple, suffered severe setbacks during similar stages of their development. Moreover, at the time these new tech companies emerged, not in hindsight, it was not easy to tell which would succeed and which would fail, like IBM. If you examine all these cases, you will see: major new technology companies naturally have highly uncertain futures.

For example, they either overinvest or underinvest. The reason is that if they don't invest enough to win the competition, they will surely lose; but they cannot know the future precisely enough to determine if they have already overinvested. Both overinvestment and underinvestment are costly.

Furthermore, they cannot accurately foresee all changes, including exogenous ones like monetary tightening, wars, or major tax changes, all of which will affect them. Consequently, they all experience dramatic upward and downward cycles: first exciting investors, then scaring them, washing out fragile investors, ultimately leading to exaggerated market volatility. Moreover, just as these new technologies and companies disrupted their predecessors, most will eventually be disrupted by newer technologies and companies in ways we cannot currently imagine. Therefore, we should also consider whether the same risks apply to today's new technologies and tech companies. The impact of quantum computing is one of the known known risks. What about the risks that haven't even been imagined yet?

What about the risk from competitors? For example, China is producing and distributing AI technology, and Chinese policymakers have a completely different perspective on the economy and AI. We are in a new technology war, and leaders in various countries believe they must win it. Their understanding of AI and its impact on the economy and people's well-being will lead them to offer this technology for free or at low cost, because of its massive productivity gains and ability to raise living standards overall. In their view, profits are less important than the overall benefits of many people using these new technologies. I believe they will compete in international markets, just as they have with cars, solar panels, batteries, and many other products.

The current set of conditions closely resembles many historical cases that offer valuable lessons. I can't help but think of how Britain defeated the Netherlands in shipbuilding and other key industries at the end of the Dutch Empire and the beginning of the British Empire. Additionally, there is a geopolitical conflict surrounding Taiwan, which should at least make us consider the possibility that, as an instrument of geopolitical warfare, China might prevent chips from flowing out of Taiwan. AI stocks also face other risks, such as the potential rise of wealth taxes and other levies, which could force holders with large concentrated wealth in these stocks to sell; or rising anti-AI sentiment that could limit the space for companies to advance technology.

I could list more things to worry about, or equally, list a long series of huge opportunities that AI will create that I would want to bet on. I am not saying how these risks will definitely evolve, nor that one shouldn't bet on AI companies. I am simply saying that there is indisputably a lot of concentrated risk in the market; and people should know how to deal with this environment. Based on my study of all similar cases and the logical reasons behind them, I am confident that risks are high, and the best way to deal with this environment is:

Diversify Well

You may know my mantra is "diversification." My "Holy Grail of Investing" is striving to hold 15 high-quality, mutually uncorrelated, and risk-balanced investments. In other words:

A well-diversified portfolio of good bets will outperform a single concentrated bet. It has a better risk-return profile and can be engineered to achieve better returns at the same level of risk. The more risk is concentrated in one area of the market, the more one should diversify; this is especially true when markets are driven by revolutionary new technologies, which inherently create enormous uncertainty.

This is not an opinion, but a mathematical certainty. For example, if I take an investment with a risk-return ratio of 0.3, let's assume a return of 6% and a standard deviation of 18%, which is a typical assumption for stocks; then, if I hold 5, 10, or 15 uncorrelated investments, I can achieve the same 6% return, but the risk measured by standard deviation would drop to 8%, 6%, and 5% respectively. Therefore, by holding 15 high-quality, uncorrelated investments, my risk-return ratio improves by 4.3 times, from 0.3 to 1.29. If you wish, you could then add leverage on top of this to achieve much higher returns at the same risk level. This is a fact.

I have a strong conviction about this. The reasons come from my backtests, the actual returns I have delivered over a 50+ year investment career, and the probabilistic logic behind it: diversifying good bets and adjusting them to the desired level of volatility will, over the long term, produce much better returns than the concentrated bets most investors tend to hold. More specifically, through good diversification, one can achieve a better risk-return ratio than any concentrated bet; then, by adjusting this portfolio to the desired level of risk, one can achieve higher returns at that target risk level, superior to any other process.

Because I am now passing this method on, it is my "not-so-secret" investment success formula. Nevertheless, I rarely meet investors who think about their investment strategy this way. That is, I rarely meet people who truly think in terms of portfolio construction—considering how a well-structured, diversified set of bets would perform compared to concentrating holdings in the stocks of a great new transformative industry. Most people just think about whether these stocks and this industry will perform well and how to bet on them. The ultimate performance outcomes between those who think about portfolio construction and those who do not will be vastly different. Therefore, I will elaborate more fully another time on my thoughts about how to do this well.

For all these reasons, in the current set of conditions, thinking about how to play the hand you are dealt should lead one to ask: How large a concentrated bet should I actually have? And then diversify.

Returns Look Likely to Be Low

High risk is indisputable. Next, I will offer a potentially wrong view: future expected returns are low. My judgment on future expected returns comes from valuation-related analysis and my bubble indicator readings: the real return on stocks over the next 5 to 10 years looks to be around -5% to -10%, although these numbers have considerable uncertainty. In my view, these stocks are long-duration assets, highly risky because it's hard to reliably see the distant future; they appear expensive, and their holder base is not robust.

A Question from My Research Team on This Topic

In a recent meeting, a member of my research team asked me: Why do you think the market's current configuration is wrong? How do you know that the current lack of diversification isn't for sound reasons? For instance, some investors believe the expected returns on AI stocks are very high; or, when an industry accounts for such a high proportion of total market capitalization, this index concentration occurs naturally; or, when an industry is met with a lot of enthusiasm, many investors buy these stocks without making smart and reliable calculations about what future earnings will be or how they should be reflected in stock prices.

My Reply

There are various reasons prices go up, and not all are good. Some investors think about prices and push them higher because they find them attractive relative to fundamentals; some hold these stocks long-term because they recognize it's a great new technology and see price increases as confirmation that these are good stocks; and some have index exposure, which gives them a large passive weight in these stocks. In my view, you can wrestle with these questions to decide what you want to do, or realize you don't need to wrestle with them because you simply don't have enough information to bet confidently. You can simply say: "I don't know enough to bet." And then not bet.

What gets people into trouble is thinking they must have an opinion and that their opinion is valuable, when it's more likely they cannot form an opinion reliable enough to be worth betting on.

Footnote: To be clear, I am not suggesting avoiding bets. Besides, you can't avoid betting because you must put your money into some investment or cash. Most people view cash as the lowest risk investment, but over the long term, it is almost certainly the worst. What I am suggesting is knowing how to diversify your bets well, even if you have no tactical views on which markets are good or bad. The way to achieve this is to have a well-balanced strategic asset allocation portfolio and hold it when you don't have a tactical view with enough conviction to bet. But that is a topic for another time.

Therefore, I believe: Knowing what you don't know, and thus deciding when not to bet, is just as important as knowing what you do know, and thus deciding when to bet.

More simply, I believe in the following principle: Because it is usually difficult to know enough to justify a concentrated bet, the best way is to hold only a diversified portfolio composed of your highest-conviction, uncorrelated bets, and engineer that portfolio to your desired risk level. That is my "Holy Grail of Investing."

Right now, given the current set of conditions, I don't think anyone knows clearly enough what will happen next in this technology-driven market to make a large, concentrated bet. In my view, avoiding concentration and maintaining diversification is the best way to handle this "not knowing." I know this contradicts what you might read in textbooks. Textbooks essentially say markets are efficient, so you should "trust the market."

In summary, the current market is exceptionally concentrated and revolves around a revolutionary new technology. This fact should remind us: not to confuse our excitement about a new technology with the attractiveness of its stocks; and not to set aside caution to hold a group of high-risk, highly correlated concentrated bets. Especially not when we can achieve equally attractive returns with much lower risk through smart diversification.

P.S. I will not share my specific holdings or tactical views with you, as I don't want to be your investment advisor. But I will soon share some key perspectives behind these views, including my bubble indicator readings and the logic behind them.

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