Ray Dalio’s Principles Applied to Financial Independence

I must admit that I have a mild obsession with Ray Dalio. You may know Dalio as the founder of Bridgewater Associates, one of the largest hedge funds on earth. But to think of him as “just some hedge fund guy” is to miss the point of much of his life’s work. Dalio stresses the importance of radical honesty and radical transparency in the workplace. He describes Bridgewater as an Idea Meritocracy, a place where the best ideas win favor, in contrast to some places where individual ego, biases and politics prevail. He is a man of reason and logic, which is probably why I like his ideas so much.

Last year, Dalio published a book called Principles. Principles was originally written as an essay which was a short summary of the core principles that Dalio believed to be the most important guidelines for structuring one’s personal and professional life. Since these principles had widespread applicability, he shared them with both his employees at Bridgewater, as well as the public at large.

Principles was available for years as a free pdf on Bridgewater’s website. I read it some time ago and was immediately struck by the common sense and logic behind much of the text. It’s simply written, can be understood by a fourth grader, and is full of sound lessons on how to live your life and be successful. Also, I believe Principles is especially relevant for people looking to improve their financial standing. I think everyone should at least read the first 30 pages of the pdf, which will give you a good understanding of Dalio’s philosophy.

In this post, I will demonstrate how Ray Dalio’s principles can help you on your journey to financial independence.

Ray Dalio’s Principles Applied to Financial Independence

Dalio is a fervent student of the continual improvement process that I have spoken of previously, and that I believe is essential to personal progress. In Principles, he introduces a 5-step process for getting what you want out of life. This process can be applied to personal goals, professional goals, or almost any problem that we encounter in our daily lives.

Cogs in the financial independence machine

The 5-Step Process of Personal Evolution

  1. Goals – have clear goals
  2. Problems – identify and don’t tolerate the problems that stand in the way of your goals
  3. Diagnosis – accurately diagnose these problems
  4. Design – design plans that will get you around your problems and on to your goals
  5. Do it! – implement these plans

Dalio’s five steps are fairly self-explanatory. Create goals, identify the problems that prevent you from achieving your goals, diagnose the cause of the problems, make a plan to solve your problem/achieve your goal, and execute!

Let’s now apply the 5-step process of personal evolution to the goal of financial independence. I will speak in generalities here, but feel free to think about your own circumstances as we go through this exercise.

Principles Applied to Financial Independence

Step 1: Goal – achieve financial independence within 10 years

For readers of a personal finance blog, this is probably a primary goal for most of us, regardless of what ‘financial independence’ means to you. Some of us may be looking for full-on retirement, while others may just want to switch gears and pursue ‘passion projects’ instead of the 9-to-5 grind. Some people may continue working after reaching FI, but breath easier with the knowledge that he or she has financial security.

The point here is that you clearly state your goal. You need to be specific about what you are trying to achieve. Make sure to include a time element (projected FI date), because without a specific timeline, it will be difficult to design a plan to reach your goal.

If “reach FI” is too large a goal at this point, start smaller. Maybe you want to eliminate debt, or shift careers as part of your financial plan. Remember that you can have anything, but you can’t have everything. Pick your targets, and then attack them.

Step 2: Problem – poor cash flow

For many people struggling to improve their financial situation, the main problem can be thought of as a cash flow issue. In the simplest terms, cash flow can be defined by the following equation:

Cash Flow  = Income – Expenses

Some people have a negative cash flow, meaning they spend more than they earn. They will spend their lives running up credit card balances and living paycheck-to-paycheck. Others break even each month (cash flow neutral) or save a small amount, which is good because it means they are not incurring any debt. But these people are also not making much financial progress, and their lives could easily be derailed by a large bill, job loss, or other unexpected expense.

In order to achieve FI, you need to build up your investments to the point where passive income generated by these investments can cover your expenses. In order to reach this investment goal, you will need to maximize your cash flow in order to reduce your time to FI.

As you can guess, there are many factors that will affect your cash flow optimization. Where you live, your job, your commute, your relationships, eating habits, etc etc… Some of these lifestyle choices may contribute to your inadequate cash flow.

When identifying the problem, be as specific as possible, and try to identify the root cause of your cash flow issues. “I don’t make enough money” is not the problem. A more appropriate problem statement might be, “I live in an oversized, expensive house and pay for spa treatments for my dog each month, because I don’t want him stinking up my new Mercedes.” Now we’re getting somewhere!

Step 3: Diagnosis – misaligned priorities 

As I just mentioned, you must get to the root cause of the cash flow issue that is preventing you from making progress toward your goal. This will probably be the most difficult step for most, because it requires you to be honest with yourself. Sometimes we have to make tough realizations about our lifestyles and how we choose to live and spend.

Maybe you feel that you need to impress your coworkers with fancy apartments and new cars. Maybe you have a shoe fetish. Or maybe you are just stuck in a dead-end job, and need to re-energize your career.

Pain + Reflection = Progress

Dalio keeps coming back to this point. We only can make true progress through pain. Sometimes you have to put yourself in an uncomfortable position before you can move forward. You have to “touch a nerve.”

Once you’ve determined the underlying cause of your cash flow issues, it’s time to plan your solution.

Step 4: Design 

Now, try to visualize the problem. If it’s a lifestyle inflation issue, think back on the lifestyle you had when you earned less money. Were you really less happy? Probably not. So why did anything change when your earnings increased? Maybe you never even thought about that before.

Once you’ve visualized the problem, you can start to visualize a practical solution. Again, this isn’t necessarily easy, but it is necessary. Before you bought the luxury sedan, your previous car still got you to work. Maybe you can downgrade your vehicle. The little Thai takeout place down the street was great for cheap Friday night eats, so why did you start going to Michelin star restaurants? How many shoes do you actually need, when you only have two feet!?!?

Next, make a list. A set of actionable tasks that can set you on your path to achieving your goal. These tasks can be small, large, or anywhere in between.

  • Start shopping for clothing at consignment shops
  • Downgrade my living situation to a smaller place with an easier commute
  • Trade in my car for a cheaper model, or better yet ditch it! (if public transportation is an option)
  • Start cooking more meals at home, and meal plan for weekday lunches
  • Make your case for a promotion at work, or look for new career opportunities

It’s important not to skip the design step. The planning is critical to your long-term success with achieving your goal.

Step 5: Do it!

Now that you’ve determined your goal, identified problems and formed a plan for overcoming those challenges, it’s time to execute. Use the list you came up with in the design stage as a guide. If it helps, subdivide each of your action items into smaller parts.

The key here is progress. The process is iterative, meaning that you will inevitably have to make adjustments along the way. Nothing goes exactly according to plan, but if you have clear objectives and are creative with your solutions, you will do just fine.

I encourage you to read more about Ray Dalio’s philosophy (links below), and to pursue your goals using his methodology of achieving success in life. Cheers!

More Ray Dalio Resources

  • Principles has a website, with more information about the book and some other resources.
  • Check out this Freakonomics Radio podcast featuring an interview with Dalio to better understand his views and mission.
  • Dalio has created a YouTube channel to share educational cartoons based on Principles.
  • Dalio also created a YouTube video called “How the Economic Machine Works.” This is an excellent video that explains the basics of economics and finance to nonprofessionals. I watch this video at least once a year.

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