Ray Dalio: The Light of Major Investment Cycles

Introduction: This article is Chapter Two of Ray Dalio’s book Principles: Life and Work, focusing specifically on how to allocate investment portfolios within a big cycle framework.

Dalio reveals a disturbing fact through real historical data: over the past century, seven out of ten major great powers have had their wealth nearly wiped out at least once—and most investors have never studied this history. In today’s context of increasing global order friction, this analytical framework’s reference value far exceeds that of typical macro commentary.

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Last week, I shared a chapter from my 2021 book Principles: Life and Work, which details the classic signals and evolution processes to watch for during the disintegration of the world geopolitical order within what I call the “big cycle.” This article was very popular, with over 75 million views, and many asked what it means for investing.

Because of the many inquiries, I am now sharing the next chapter from the book—Investing in the Big Cycle. I believe it offers valuable perspectives for current investments. You can read the full chapter below.

Additionally, since many are interested in my investment principles, I will be sharing them gradually over the next few weeks. If you want to receive notifications when I publish, please subscribe to my newsletter Principled Insights or sign up for email alerts.

My approach to life and career is to try to understand how the world works, develop guiding principles accordingly, and then position myself. The research I share in this book is precisely for that purpose.

Naturally, when I review everything involved up to this point, I think about how to apply it to investing. To be confident in my approach, I need to understand how my methods would have performed historically. If I cannot confidently explain what happened in the past—or at least have a strategy to handle the unknown—I see that as a dangerous oversight.

As my research over the past 500 years shows, history features large cycles of wealth and power accumulation and loss, driven mainly by debt and capital market cycles. From an investor’s perspective, this can be called the “big investment cycle.” I believe it’s essential to understand these cycles thoroughly so that I can tactically shift or diversify my portfolio to hedge against or profit from them. By understanding these cycles and, ideally, judging where each country stands within its cycle, I can do just that.

Over my roughly 50-year global macro investing career, I have uncovered many universal truths across time and regions that form my investment principles. While I won’t delve into all principles here—most will be discussed in my next book Principles: Economics and Investing—I want to convey one key principle.

All markets are driven by four factors: growth, inflation, risk premiums, and discount rates.

This is because all investments are essentially exchanges between a one-time payment today and future payments. Future cash flows are determined by growth and inflation; the risk premium reflects how much risk investors are willing to bear compared to holding cash; and the present value of those future payments is determined by the discount rate.

Changes in these four factors drive changes in investment returns. If I know how each will evolve, I can predict how investments will perform. Understanding this allows me to connect what’s happening in the world with market movements—and vice versa. It also guides me in balancing my investments, ensuring my portfolio isn’t biased toward any particular environment, which is the essence of good diversification.

Governments influence these factors through fiscal and monetary policies. The interaction between what governments expect to happen and what actually happens is the engine of cycles. For example, when growth and inflation are too low, central banks create more money and credit, boosting purchasing power, which initially accelerates economic growth, followed by rising inflation (with a lag). Conversely, when central banks restrict money and credit growth, the opposite occurs: economic growth and inflation slow down.

The actions of the central government and the central bank differ. The government controls where its funds come from and go—through taxation and spending—but cannot create money and credit. The central bank can create money and credit but cannot decide which sectors of the real economy these funds enter. Their actions influence the buying and selling of goods, services, and investment assets, pushing prices up or down.

To me, each asset class reflects these drivers in its own way, consistent with how they impact future cash flows. Each asset is a component of the portfolio, and the challenge is to combine them rationally, considering these factors.

For example, when growth exceeds expectations, stock prices may rise if all else remains equal; when growth and inflation are higher than expected, bond prices may fall.

My goal is to assemble these modules into a balanced, diversified portfolio that is tactically tilted based on current or anticipated impacts of these four drivers. These modules can be broken down by country, environment preferences, industry, and individual companies. When applied to a balanced portfolio, the effect is shown in the diagram below. This is how I analyze historical events, market history, and portfolio behavior through this lens.

I know my approach differs from most investors for two reasons. First, most don’t seek historical analogs because they believe history and past returns are largely irrelevant to them. Second, they don’t view investment returns through the perspective I just described. I believe these perspectives give me—and Bridgewater—a competitive advantage, but whether to adopt them is up to you.

Most investors set expectations based on their lifetime experiences; fewer are diligent enough to review history and see how their decision rules would have performed in the 1950s or 1960s. Among the investors I know—and I know many, including top economic policymakers—none have an excellent understanding of what happened in the past and why. Most who look at long-term returns use data from the U.S. and U.K. (the countries that won the World Wars) as representative.

That’s because few stock and bond markets survived after WWII. But these countries and periods are not representative—they suffer from survivor bias. Looking at U.S. and U.K. returns means examining the most fortunate countries during the best big cycle periods. Ignoring other countries and earlier periods creates a distorted view.

Starting from the known big cycle knowledge and reasoning forward over decades, examining different places, yields a startlingly different perspective. I will demonstrate this because I believe you should understand it.

In the 35 years before 1945, nearly all wealth in most countries was destroyed or confiscated. In some countries, when capital markets and capitalism collapsed along with other aspects of the old order, many capitalists were killed or imprisoned—driven by anger against them.

Looking back over centuries, we see such extreme boom/bust cycles occurring regularly—periods of prosperity (like the late 19th and early 20th centuries’ Second Industrial Revolution and Gilded Age) followed by transitional periods (like the 1900s-1910s with internal conflicts and international power struggles), leading to major conflicts and depressions (like those from 1910 to 1945).

We can also see that the causal relationships behind these boom and bust periods are now more similar to the late-cycle depressions and restructuring phases than to early periods of prosperity and growth.

My goal is simply to observe and understand what happened in the past and then do my best to show it to you. That’s what I am attempting now. I will start from 1350, even though the story began long before that.

Big Cycles of Capitalism and Markets

Around 1350, charging interest on loans was prohibited by Christianity and Islam—also forbidden within Jewish communities—because it caused serious problems: human nature led people to borrow beyond their ability to repay, creating tension and often violence between borrowers and lenders. Due to the lack of lending, money was “hard currency” (gold and silver). About a century later, during the Age of Discovery, explorers traveled the world collecting gold, silver, and other hard assets to accumulate more wealth. This was the main way wealth was accumulated at the time. Explorers and their sponsors shared profits, creating an effective incentive-based wealth system.

The modern concept of lending magic—creating new money—was first developed around 1350 in Italy. Lending rules changed, and new forms of currency emerged: cash deposits, bonds, and stocks, very similar to what we know today. Wealth became promises to pay in money—what I call “financial wealth.”

Think about how much impact the invention and development of bond and stock markets had. Before that, all wealth was tangible. Imagine how much more “financial wealth” was created by these markets. To grasp the difference: if your cash deposits and future payments from stocks and bonds didn’t exist, how much “wealth” would you have now? Almost nothing—you’d feel bankrupt and behave differently—like saving more tangible assets. That was roughly the state before the creation of cash deposits, bonds, and stocks.

With the invention and growth of financial wealth, money was no longer tied to gold and silver. Because money, credit, and purchasing power were less constrained, entrepreneurs could start companies, borrow, and sell shares to raise funds. They could do this because promises to pay became entries in ledger accounts—money in a form of bookkeeping.

Around 1350, those who could do this—most famously the Medici family of Florence—could create money. If you could create credit—say, five times the actual money (which banks could do)—you could generate enormous purchasing power, reducing the need for other types of money (gold and silver). The creation of new money was, and still is, a form of alchemy. Those who could create and use it—bankers, entrepreneurs, and capitalists—became very wealthy and powerful.

This process of expanding financial wealth has continued to this day, to the point where tangible assets like gold, silver, and real estate have become relatively less important. But of course, the more promises in the form of financial wealth that exist, the greater the risk that these promises cannot be fulfilled. This is the root cause of classic debt/money/economy cycles. Think about how much financial wealth exists today relative to real wealth, and imagine you and others holding this financial wealth trying to convert it into real wealth—selling it to buy goods. It’s like a bank run. That can’t happen. The value of bonds and stocks relative to what they can buy is too large. But remember, under a fiat currency system, central banks can print money to meet demand. This is a universal truth across time and space.

Also remember, paper money and financial assets (like stocks and bonds), which are essentially promises to pay, are of limited use in themselves; what matters is what they can buy.

As discussed in Chapter 3, when credit is created, purchasing power is created along with the promises to pay, providing a short-term stimulus but a long-term restraint. This creates cycles. Throughout history, the desire to acquire money (through borrowing or selling stocks) and the desire to store money (through lending or investing in stocks) have been symbiotic. This leads to growth in purchasing power, eventually creating payment promises far exceeding deliverable assets, resulting in default crises like debt defaults, depressions, and stock market crashes.

At those times, bankers and capitalists were literally and figuratively hanged, vast wealth and lives were destroyed, and large amounts of fiat currency (printable but valueless money) were issued in an attempt to ease the crisis.

The Complete Big Cycle from an Investor’s Perspective

While it’s too burdensome to review all relevant history from 1350 to now, I will show what it would look like if you had invested starting in 1900. But first, I want to explain how I view risk, because I will emphasize these risks in the following.

To me, investment risk is not just volatility measured by standard deviation—though that’s almost exclusively used—but the risk of not earning enough to meet your needs.

Most investors face three major risks: their portfolio not providing enough return to cover expenses, their portfolio being wiped out, and most of their wealth being confiscated (e.g., through high taxes).

While the first two seem similar, they are different because it’s possible to have high average returns but suffer one or more catastrophic losses.

To gain perspective, I imagine myself in 1900 and look at how my investments would have performed each decade since then. I focus on the ten most powerful countries at that time, skipping less developed nations more prone to bad outcomes. Any of these countries could have become or been a great wealthy empire; they are all reasonable investment locations, especially for diversification.

Among these ten countries, seven experienced at least one near-total destruction of wealth—those that didn’t saw decades of terrible asset returns, nearly leading to financial ruin. Two major developed countries—Germany and Japan—are often considered likely winners, but in both world wars, nearly all wealth was destroyed, and many lives lost. I see similar results in many other countries. The U.S. and U.K. (and a few others) are particularly successful cases, but even they experienced periods of massive wealth destruction.

If I hadn’t examined the returns before 1945—the start of the postwar world order—I wouldn’t see these destructive periods. Without reviewing 500 years of global history, I wouldn’t see how these events recur in nearly every place.

The numbers in the table show the annualized real return for each decade, meaning that losses over the decade are roughly eight times the number shown, and gains about 15 times.

Perhaps the chart below offers a clearer picture, showing the proportion of major countries holding a 60/40 stock/bond portfolio that experienced losses over five-year periods.

The table details the worst cases of investment in these countries. Notice that the U.S. does not appear here because it’s not among the worst cases. The U.S., Canada, and Australia are the only countries that did not experience sustained periods of loss.

Of course, I think about how I would have responded during those times. I can say with certainty that even if I saw signs of what I’ve shared in this book coming, I would never confidently predict such terrible outcomes—like seven out of ten countries having their wealth wiped out. In the early 20th century, even those reviewing the past decades would never have foreseen this, because based on the second half of the 19th century, there was ample reason for optimism.

Today, people often assume that the outbreak of WWI was predictable in the years before, but that’s not true. Before the war, the major powers experienced nearly 50 years of relative peace. During that time, the world saw the largest innovations and productivity growth in history, bringing enormous wealth and prosperity.

Globalization peaked, with exports multiplying several times in the 50 years before WWI. Countries were more interconnected than ever. The U.S., France, Germany, Japan, and Austria-Hungary were rapidly rising empires experiencing dizzying technological progress. Britain remained the dominant global power. Russia was industrializing quickly.

Among the countries with the worst investment records, only China was clearly in decline. The strong alliances among European powers were seen as means to maintain peace and balance of power. By 1900, everything looked good—except for growing inequality, resentment, and debt. Between 1900 and 1914, these conditions worsened, tensions escalated, leading to the terrible returns I described earlier.

But the situation was worse than just poor returns.

Moreover, wealth confiscation, confiscatory taxes, capital controls, and market closures had huge impacts. Most investors today are unaware of these events and believe they can’t happen because they don’t see them in recent history. The table below shows when these events occurred.

Naturally, the most severe cases of wealth confiscation happened during periods of high inequality, economic deterioration, and internal conflicts over wealth, and/or during wars.

The next chart shows how the proportion of stock market closures in major countries has changed over time. Wartime closures are common, and communist countries also closed their markets for over a generation.

All the bad cycles before 1900 were just as bad. Even worse, these periods of internal and external struggles over wealth and power led to massive deaths.

Even for investors in countries that won wars (like the U.S., which was the biggest winner twice), there are two additional hurdles: market timing and taxes.

Most investors sell near lows because they need money and panic; they buy near highs because they have ample funds and are driven by euphoria. This results in worse actual returns than the market averages I’ve shown. Recent studies indicate that from 2000 to 2020, U.S. investors underperformed U.S. stocks by about 1.5 percentage points annually.

Regarding taxes, the table estimates the average impact of taxes on S&P 500 investors over 20-year periods (using the top 20% income tax rate today). Different columns show various ways of investing in U.S. stocks, including tax-deferred retirement accounts (taxes paid only at withdrawal) and regular brokerage accounts where dividends are reinvested annually.

While these approaches have different tax implications—retirement accounts having the least impact—all show significant effects, especially on real returns, as taxes can erode a substantial part of gains. On average, U.S. investors lose about a quarter of their real stock returns to taxes over any given 20-year period.

Reviewing Major Market Cycles

Earlier, I explained how classic debt and capital market cycles work. To reiterate: during the upswings, debt increases, and financial wealth and obligations grow relative to tangible assets until these future promises (cash, bonds, stocks) can no longer be fulfilled.

This leads to “bank run” style debt problems, prompting money printing to avoid defaults and stock crashes, which causes currency devaluation, a decline in real financial wealth relative to real assets, until the cycle resets with a new phase of growth.

This is a simplified description, but you get the idea—during the downturn, real returns on financial assets are negative, and times are tough. This is the anti-capital, anti-capitalist phase, lasting until the opposite extreme is reached.

This cycle is illustrated in the following two charts. The first shows the total value of financial assets relative to real assets. The second shows the real return on cash. I use U.S. data because it’s the most continuous since 1900. As you see, when financial wealth greatly exceeds real wealth, a reversal occurs, and the real return on financial assets (especially cash and debt assets like bonds) becomes very poor.

This is because debt holders’ interest rates and returns must stay low to provide relief for heavily indebted borrowers and to stimulate more debt growth. It’s the classic late stage of a long debt cycle.

It happens when more money is printed to ease debt burdens and new debt is created to boost purchasing power. This causes currency to depreciate relative to other stores of wealth and goods/services.

Eventually, as the value of financial assets declines until they become cheap relative to real assets, the cycle reverses, peace and prosperity return, and the cycle enters an expansion phase with strong real returns on financial assets.

As mentioned earlier, during currency devaluation periods, the value of hard assets and hard currencies relative to cash rises. For example, the next chart shows that periods of declining 60/40 stock/bond portfolios coincide with rising gold prices. I’m not claiming gold is a good or bad investment—just describing the mechanisms and how they’ve played out in past markets and returns, to share my perspective on what has happened, what might happen, and why.

Investors should regularly ask themselves: does the interest paid compensate for the risk of devaluation?

The classic debt/money/market cycle repeats across history, reflected in the charts I just showed, as:

1. The relative value of tangible money and assets versus financial money and assets. Financial assets only have value if they can be exchanged for real, intrinsic-value money and wealth.

These cycles always operate similarly: during the uptrend, the quantity of financial money and assets (debt and equity) increases relative to real money and assets.

This increase is driven by:

a) Profitable activities of capitalists creating and selling financial assets;

b) Policy makers’ effective way to create prosperity by injecting money, credit, and other capital market assets to meet demand;

c) When the book value of financial investments rises due to declining value of money and debt assets, it creates an illusion of greater wealth. This has historically led governments and central banks to create financial claims far exceeding what can be exchanged for real wealth and real money.

During the uptrend, as interest rates fall, stock, bond, and other asset prices rise because lower rates tend to push up asset prices if all else remains equal. Simultaneously, injecting more money into the system increases demand for financial assets and lowers risk premiums.

As these investments rise due to falling rates and more money in the system, they appear more attractive, while interest rates and expected future returns decline.

Unclaimed claims relative to the underlying assets increase risk. This should be offset by higher interest rates, but often isn’t, because conditions seem good, and memories of debt and market crises fade.

The charts I previously used to illustrate cycles are incomplete without some interest rate data. The next four charts, tracing back to 1900, show U.S. real (inflation-adjusted) bond yields, nominal yields, and nominal and real cash interest rates. As you see, they were much higher in the past and are now very low.

At the time of writing, real yields on reserve currency sovereign bonds are near historic lows, nominal yields around 0%, also close to historic lows. As shown, real yields on cash are even lower, though not as negative as during the 1930-45 and 1915-20 printing episodes. Nominal cash yields are also near all-time lows.

What does this mean for investing? The goal is to store wealth in a way that preserves purchasing power for future use. When investing, you exchange a lump sum today for future payments.

Let’s see what that looks like as of this writing. If you invest $100 today, how many years will it take to get back your $100 and start earning on your principal? In bonds from the U.S., Japan, China, and Europe, you might need about 45, 150, and 30 years, respectively, to recover your money (likely with low or zero nominal returns), and in Europe, with negative nominal rates, you might never recover your principal.

But since you’re trying to preserve purchasing power, inflation must be considered. As of now, in the U.S. and Europe, you might never regain your purchasing power (in Japan, over 250 years). In countries with negative real rates, you’re almost certainly losing purchasing power over time.

Instead of earning below inflation, why not buy something—anything—that’s worth at least as much as inflation? I see many investments I expect will significantly outperform inflation. The chart below shows the recovery periods for holding cash and bonds in the U.S., in nominal and real terms. As shown, it’s the longest in history—an absurdly long period.

Conclusion

What I’ve shown here is the big cycle from an investor’s perspective since 1900. When reviewing 500 years of global history and 1,400 years of Chinese history, I see the same fundamental cycles recurring for the same fundamental reasons.

As discussed earlier, the terrible periods before 1945—the establishment of the postwar order—are typical late-stage features of the big cycle, when revolutionary changes and restructuring were underway. While these periods are frightening, they are far worse than the astonishing upswing that follows the painful transition from the old order to the new. Because these events have happened many times before, and I cannot predict what will happen next, I cannot invest without safeguards against these events and my own misjudgments.

Footnotes

[1] The discount rate is the interest rate used to evaluate the present value of future money. It’s calculated by comparing how much you’d need to invest today at that rate to have a specific amount at a future date.

[2] If the government and its system collapse, non-governmental forces will take over—another story I won’t delve into here.

[3] You can see this alchemy at work today in digital currencies.

[4] When compounded over ten years, gains outpace losses because you continually accumulate on gains; when losses approach zero, future percentage losses have less impact in dollar terms. Comparing annualized gains and losses reflects compounding from an average 10% annual return and -5% annual loss. In more extreme changes, the multiplier begins to shift.

[5] For China and Russia, bond data before 1950 are modeled based on hard currency bond returns, assuming hedging against local currencies; stocks and bonds during revolutions are modeled as complete defaults. The annualized return assumes a full 10-year period, even if markets closed during that decade.

[6] Poor asset return cases for smaller countries like Belgium, Greece, New Zealand, Norway, Sweden, Switzerland, and emerging markets are not included here. For simplicity, only the worst 20-year windows are shown (e.g., Germany 1903-1923, excluding 1915-1935). For our 60/40 portfolio, we assume rebalancing monthly within these windows.

[7] Although not exhaustive, I list clear evidence of each event occurring within 20-year periods. Wealth confiscation is defined as large-scale expropriation of private assets, including government or revolutionary forced sales. Capital controls are meaningful restrictions on moving funds in or out of countries and assets (excluding targeted measures like sanctions).

[8] The tax impact on 20-year investments in the S&P 500 is estimated using today’s top 20% income tax rate (from Congressional Budget Office, 2017). Different columns show various investment methods, including tax-deferred retirement accounts (tax paid only at withdrawal) and taxable brokerage accounts where dividends are reinvested annually. All methods show significant effects, especially on real returns, as taxes can erode a substantial part of gains. On average, U.S. investors lose about a quarter of their real stock returns to taxes over a 20-year period.

[9] Based on the 30-year nominal bond yield level as of August 30, 2021 (considered a perpetuity).