Ray Dalio: When AI Giants Dominate U.S. Stocks, I Choose Not to Bet on Direction, but to Do Only One Thing

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

Original Author: Ray Dalio, founder of Bridgewater Associates

Original Translation and Compilation: Peggy, BlockBeats

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

Dalio's core reminder is that technological progress itself does not mean related stocks are equally attractive. Major technology cycles throughout history have typically gone through phases of excitement, crowding, volatility, and washout. Even long-term winners like Microsoft and Apple have experienced significant drawdowns during these cycles. Today's AI industry faces multiple uncertainties, including overinvestment, intensifying 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 about how investors should respond to a "highly concentrated" market structure. Dalio argues that when a handful of tech companies account for an ever-increasing weight in indices, investors need to be wary of unconsciously holding a highly correlated, high-risk concentrated exposure. Instead of continuing to chase a few leaders, a truly more robust approach is to build a diversified portfolio of high-quality, low-correlation assets and adjust its volatility level 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 risks—investors should not directly translate their excitement about new technology into concentrated positions in a few AI stocks. Diversification, in Dalio's eyes, is the "Holy Grail of Investing" for navigating this technology cycle.

Below is the original text:

This note is about: How to play the investing game in the current environment.

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

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

I've 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; furthermore, I hope to create a platform where all kinds of people can explore the investment game in their own way, learn and backtest how they would have done in the past, and truly execute it well. I believe there are right and wrong ways to play the hand you've been dealt. So, when you encounter a set of conditions like X, Y, Z, you should ask yourself: "Given this situation, how should I place my bets?" 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 Navigate the Current Set of Conditions

What are the most important environmental factors right now? How should one place bets given these factors?

In my view, and likely in the view of most, the market environment we are in now is one where a handful of companies dominate the market, driven by a major new technology, primarily AI. These companies account for a very high percentage of the total market capitalization and are having a huge impact on the market and the economy. All such periods share a common feature: a great deal of excitement, uncertainty, and volatility are concentrated in the new technology sector, transmitting through it to global stock markets. Therefore, the volatility and uncertainty surrounding this sector are extremely important.

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

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 the new technology relative to a broad stock index like the S&P 500, i.e., overweight this new sector, or overweight what you consider the best few companies within it; 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 works hard to do so, and right now there is a new technology that seems to be changing almost everything. But history shows that at this stage of the cycle, most people fail by placing a very large portion of their chips on the stocks of a few leading technology companies. There is a logical reason for this, and it has always played out 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 convincingly why this time is different.

The Risk is Undoubtedly High

All past cases of major new technologies have unfolded in similar ways due to the same logical reasons. High risk and great uncertainty are inherent characteristics of these new technology companies. Looking back at the performance of such companies in similar historical environments, we see that even the best revolutionary new technology companies that thrived over the long term, like Microsoft and Apple, suffered severe setbacks at similar stages in their development. Furthermore, it was not easy at the outset of these new technology companies, rather than in hindsight, to determine which would succeed and which would fail, e.g., IBM. Observing all these cases, one sees that major new technology companies naturally have highly uncertain futures.

For example, they either over-invest or under-invest. The reason is that if they don't invest enough to win the competition, they will surely lose; but they cannot know the future accurately enough to judge whether they have over-invested. Both over-investment and under-investment are costly.

Moreover, 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 up-and-down cycles: first exciting investors, then scaring them, washing out fragile investors, and ultimately leading to exaggerated market swings. Furthermore, just as these new technologies and companies have disrupted their predecessors, most of them will eventually be disrupted by newer technologies and companies in ways we cannot imagine in advance. Therefore, we should also consider whether the same risk applies to these current new technologies and tech companies. The impact of quantum computing is one known known risk. What about risks not yet imagined?

And what about the risk from competitors? For instance, 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 national leaders believe they must win it. Their understanding of AI and its impact on the economy and people's well-being may lead them to provide this technology for free or at low cost because of its immense 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.

This 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 important industries towards the end of the Dutch Empire and the beginning of the British Empire. Additionally, there is a geopolitical conflict over Taiwan that should at least make us consider the possibility that China might block the flow of chips from Taiwan as a tool of geopolitical warfare. AI stocks face other risks too, such as the potential for higher wealth and other taxes, which could force sales by those holding large amounts of wealth concentrated in these stocks; or rising anti-AI sentiment, which could limit the space for companies to advance the technology.

I could list more things to worry about, but I could also list an equally long list of huge opportunities that AI will create and that I would want to bet on. I'm not saying how these risks will definitely play out, nor am I saying one shouldn't bet on AI companies. I'm simply saying it's indisputable that a large amount of concentrated risk exists in the market; and people should know how to navigate such an environment. Based on my study of all similar cases and the underlying logic, I am confident that the risks are high, and the best way to navigate this environment is:

Diversify Well

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

A well-diversified portfolio of high-quality bets will outperform any single concentrated bet. It has a better risk-return ratio and can be engineered to deliver better returns at the same level of risk. The more risk concentrated in one area, the more one should diversify; this is especially true when the market is driven by revolutionary new technology, which inherently generates enormous uncertainty.

This isn't an opinion; it's a mathematical certainty. For example, if I take an investment with a risk-return ratio of 0.3—assuming a 6% return and 18% standard deviation, which is typical for stocks—and hold 5, 10, or 15 non-correlated investments, I could achieve the same 6% return, but the risk measured by standard deviation would drop to 8%, 6%, and 5% respectively. So, by holding 15 high-quality, non-correlated investments, I improve my risk-return ratio by 4.3 times, from 0.3 to 1.29. If you wanted, you could even add leverage on top of that to get a much higher return at the same risk level. That's a fact.

I am very confident in this. The reasons come from my backtests, my actual track record of returns over 50+ years of investing, and the probabilistic logic behind it: well-diversified bets, adjusted to one's desired volatility level, will produce far better long-term returns than the concentrated bets most investors tend to hold. More specifically, with good diversification, one can achieve a better risk-return ratio than any concentrated bet; then, by adjusting it to one's desired risk level, one can achieve higher returns at that target risk level than with any other process.

Because I'm passing this method on, it's now my "not-so-secret" formula for investment success. Nevertheless, I rarely encounter investors who think about their investment strategy this way. Meaning, I rarely encounter people who truly think from a portfolio construction perspective—considering how a well-structured, diversified set of bets could perform differently compared to holding concentrated positions in the stocks of a great new revolutionary sector. Most people just think about whether these stocks and this sector might perform well and how to bet on them. There will be a huge difference in performance outcomes between those who think about portfolio construction and those who don't. Therefore, I will elaborate more fully on my thoughts on how to do this at another time.

For all these reasons, thinking about how to play your hand in the current set of conditions should lead one to ask: "What size of concentrated bet should I really be holding?" and then to diversify.

Returns Look Like They Will Be Low

High risk is indisputable. Next, I'll offer what might be an incorrect view: expected future returns are low. My judgment on expected future returns comes from valuation work and my bubble indicator readings: the real return for stocks over the next 5 to 10 years looks like it will be around -5% to -10%, although these numbers have significant uncertainty. In my view, these stocks are long-duration assets with high risk, because it is hard to see the distant future reliably; they also seem expensive, and their holder base is not stable.

One Question My Research Team Asked on This Topic

In a recent meeting, a member of my research team asked me: Why do you think the market is wrong to be configured the way it is today? How do you know the lack of diversification in the market today isn't happening for a good reason? For instance, some investors might think expected returns on AI stocks are incredibly high; or, when a sector accounts for such a high percentage of total market cap, this index concentration naturally occurs; or, when a sector is met with a lot of enthusiasm, many investors buy these stocks without making a smart and reliable calculation of what future earnings will be and how those earnings should be reflected in stock prices.

My Answer

Prices rise for various reasons, and not all of those reasons are good. Some investors think about prices and push them higher because they believe prices are still attractive relative to fundamentals; some hold these stocks for the long term because they recognize this is a great new technology and see the rising stock prices as confirmation they are good stocks; and some have index exposure, which passively gives them a large weight in these stocks. In my view, you can wrestle with these issues to decide what you want to do, or you can 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 are not able to form an opinion reliable enough to bet on.

Footnote: To be clear, I am not suggesting avoiding bets. Moreover, you cannot avoid betting because you must put your money into some investment or cash. Most people think cash is the least risky investment, but over the long term, it is almost certainly the worst. I am suggesting that even if you don't have a tactical view on which markets are good or bad, you should know how to diversify your bets well. 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 confident enough to bet on. But that's 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: Since it is usually very difficult to know enough to justify concentrated bets, the best approach is to hold only a diversified portfolio of bets you are most confident in, *that are non-correlated with each other*, and engineer that portfolio to the level of risk you are willing to bear. 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 place a huge, concentrated bet. In my view, avoiding concentration and staying diversified is the best way to deal with this "not knowing." I know this is contrary to 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 new technology with the attractiveness of the new technology stocks themselves; and not to throw caution to the wind and hold a set of high-risk, highly correlated concentrated bets. This is especially true when we can achieve similarly attractive returns with much lower risk through intelligent diversification.

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

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