Stay Invested
Edelman offers three investment strategies his firm has been providing clients since 1986. The first strategy is to stay invested. “It’s really important that you maintain a long-term horizon,” he said, pointing out that it is easy to be bombarded and distracted by daily negative news and scary headlines and tweets.
“The bottom line is it is certainly understandable to look at the daily news and allow that to persuade us into shifting our investment strategy. It’s vitally important that you stay invested, because the alternative is very bad.” He pointed to two charts. One showed a month-by-month performance of the stock market index since 1926, and the other showed performance over a 20-year period. The short-term chart showed volatility and uncertainty, while the 20-year chart showed more gains over the long term.
“At no point in any 20-year period of the past 100 years or so has the stock [market] ever lost money,” he said. “The stock market goes from being incredibly unpredictable and volatile to something that is remarkably stable and consistent. Therefore, it’s vitally important that you maintain a long-term perspective.” He suggested holding your investments for 10 years or more.
Stay Diversified
The second strategy, Edelman offers, is to stay diversified. He noted that there are 16 major asset classes and market sectors. The question is which of these should you own and in what combination. He said it is impossible to predict how the investments are going to perform merely based on how they did in the past. “Past performance does not guarantee future results. Investment returns over time are random,” he said.
But he said a lot of investors fail to understand that. “We know that tomorrow’s weather is unpredictable based on last week’s weather, and we know that this year’s sporting champion is going to be different from last year’s sporting champion. Why is it, though, that investors insist on believing that last year’s weather will be next year’s weather? It makes no sense, and it doesn’t work that way.”
And that’s why Edelman said it is so important to be diversified. “Since we don’t know what’s going to do well next, we need to own it all, all the time,” he said. For example, he said, if you invested over the last 10 years equally in all 16 of those major asset classes and market sectors, you would have earned a 7% return per year. But if you skipped the top three asset classes (the three that made the most money in each year), your return would have been 3.3%.
Edelman does not recommend owning all of the asset classes equally. He said there are variances in your situation where you might need to have more of your money in one asset class and less in another. “What your asset allocation looks like should be determined by your specific circumstances, your goals and attitude toward risk,” he said.
Strategically Rebalance
The final investment strategy—and what Edelman said is the most important element for portfolio management—is to strategically rebalance your portfolio. His firm found that investors not only never do it, but they have also never heard of it. “And the result if you don’t rebalance can be dangerous,” he said.
For example, if the stocks in your portfolio grow faster than all the other assets, then they will make up a greater portion of your total pie chart and you are no longer diversified. And while you might make a ton of money with a stock-heavy portfolio, that could be short-lived because, as everybody knows, the market crashes from time to time. “We saw it in the crash of 1987, ’08 and in April and September. And the last thing you want to have happen is for a stock market crash while all of your money is invested there.”
Edelman added that we have to recognize that different asset classes will perform differently over time. “Some will rise faster than others. Some will go up, others will go down, and what we need to do very simply is periodically rebalance,” he said. “Rebalancing helps you avoid the risk of overconcentration. It helps you avoid the problem that you might end up with too much money and too few investments.”
And when do you need to rebalance? Edelman said whenever your portfolio drifts from its original model. Also, the more volatile the markets, the more opportunity for rebalancing.