When It’s Right to Do “Nothing” for Your Portfolio

One of the biggest tests for investors — and, for savvy investors, one of the biggest opportunities — is how they behave when the market gets rocky.

There are essentially two things every investor can do when the market suffers a downturn. These might sound oversimplified, but it is important to distill these options as far as possible:

• They can do something.
• They can do nothing.

As the SVP of Investments at Fundrise, I interact with people building strategies around their financial futures every day, and the happiest investors generally (in terms of panic, stress, and overall returns) are the ones in the latter group: those who are able to sit back and comfortably watch the market follow its due course, regardless of temporary ups and downs.

Of course, they don’t enjoy this kind of luxury and confidence because they’ve truly done nothing. Rather, they’re able to view market turbulence calmly because they’ve made a series of wise decisions far in advance. These choices together construct a resilient portfolio, which means they now have the advantage of “doing nothing” while other investors feel compelled to act in the pressure chamber of the market’s volatility.

On the opposite end of the spectrum, many investors who “do something” in reaction to a declining market, do so for the wrong reasons, at the worst possible time, because they feel their hand is forced. They panic. They sell low. They see their account value dropping and they force sales because their portfolio hasn’t been properly engineered to withstand the market’s gales and tides. Or, often worse, they think they can time the market and shuffle one set of investments for another. That’s almost always a decidedly bad idea, as one of the market’s fundamental characteristics is its hazardous, stubborn unpredictability.

There are naturally exceptions: professional investors, like those steering massive institutional portfolios, are paid to court risk and are incentivized to maximize returns at all costs. They might be poised to deploy stores of cash to scoop up investments at discount prices while the market is depressed. It’s worth noting, though, that even professional investors tend to fare badly when they try to time the market. EIther way, it is their job to react, and in their own way these investors are prepared too, for this very situation. Generally, most individual investors are not prepared, and they may be much more content with one of the well-formulated portfolios that reward patient observation.

But how do you prepare properly? The answer — as it often is in investing — is diversification. That is, the construction of a portfolio across a variety of assets so that when one piece of the market moves, other pieces are likely to compensate. What I’m referring to here is not the simple stocks-plus-bonds diversification model investors have defaulted to for decades.

Instead, in today’s investing ecosystem, there is now a deeper, more fortified model of diversification available to investors at every level. And for investors interested in preparing properly, there are preemptive steps you can take immediately, today, toward a more perfectly diversified portfolio. One powerful resource is private market real estate, which is now available to everyone, not just institutional or accredited investors like in the past. This kind of real estate is an approach to the broader, key strategy: alternative, private asset classes, of which real estate is one of the most ancient and well-established types.

To see why that deeper diversification is so crucial, let’s take a look at a recent market snapshot: the stock market’s troubles in 2018.

A season of trouble for stocks

At the end of last year, stock market investors went for a bumpy ride.

Months earlier, much of the market had appeared strong, continuing the sustained growth of the longest bull market in history. But in 2018’s closing months, investors weathered a season of whiplash-inducing volatility, which pulled the stock market into a series of gut-wrenching plunges. Using Vanguard’s Total Stock Market ETF as a proxy for the whole market, we see that stocks overall ended 2018 firmly in the red for the year, with a disappointing net return of -5.13%.

Economic trouble wasn’t contained to the stock market. Other public investments correlated closely, as they typically do. Looking at real estate (as that is my specialization), public real estate investments also faltered: Vanguard’s Real Estate ETF (representing public Real Estate Investment Trusts (REITs)) finished in the same, negative range as stocks, with -5.95% net returns for 2018.

But beyond the public markets, other investments were telling a different story. Specifically, many private market investments found themselves insulated from some of that volatility and downturn.

At Fundrise, our private real estate investments delivered 2018 performance that looked quite a bit different: a platform portfolio of Fundrise assets finished 2018 with an overall positive return of 9.11%. That’s approximately 14% ahead of the stock market’s performance.

Preparation and balance

Equipped with this performance snapshot, it’s easy to empathize with an ill-prepared stock market investor and understand how they might arrive at the bad decision to take action when the market is at its lowest point: to sell at a loss, in hopes of salvaging some of their initial investment. Most people understand that’s a damning strategy, driven by panic and the psychology of feeling cornered — but the urge to do something can be overwhelming, particularly if you feel as if you’re in a crisis for which you haven’t prepared.

Embracing patience, waiting for the market to recover, goes against basic animal instincts. After all, as we’re told, the reptilian contingent of our brains are conditioned to counsel us toward “fight” or “flight”; “hold still” isn’t an option naturally on the menu, even if evidence and experience has shown us its advantages.

On the other hand, offloading stock when the market is growing isn’t necessarily the best way to avoid this kind of situation either. Most investors don’t have the goal of abandoning public markets altogether. If that same investor had instead sold their stock position earlier in 2018, before prices tumbled, they might have looked savvy by the year’s standards; but as a general strategy, that method is untenable, despite having gotten lucky and selling high.

Luck is not a reliable resource, and it can’t be counted on for repeat performance. Unless the investor were ready to completely liquidate their portfolio, totally offloading their stock holdings would be an unusually extreme move and would, of course, backfire if the stock market were to simply continue rallying.

Similarly, shuffling all stock holdings into some other asset class would not be a wise form of preparation: taking all of your eggs out of one basket and putting them into another still involves fundamental risk, no matter how tight and well-finished the new basket’s weave appears to be.

A genuinely balanced portfolio is the happy compromise that avoids both overexposure and underexposure. And for most investors, that balance would often include the stock market, even in the wake of a year like 2018.

For example, despite Fundrise’s strong track record and emphatic outperformance of the stock and public REIT markets in 2018, building a portfolio solely of Fundrise investments would not represent the kind of diversification we usually see employed by the world’s best investors. For instance, David Swenson, who has helmed the Yale Endowment’s historically successful portfolio, has popularized the idea that 20-30% of an individual investor’s portfolio be dedicated to private market real estate — not the entire portfolio.

As evidence has shown again and again, simply going beyond stocks and bonds is often not enough. Consider the failure of public real estate to perform differently than the stock market in 2018. A deeper kind of diversification would have been necessary to counteract the year’s downturn: an investment with lower correlation to the public realm. The average investor’s need for a more fundamentally diverse asset class — not just real estate but private real estate — is one of the main reasons why we founded Fundrise and why we continue to improve our portfolios for investors all over the country, making them highly accessible, low-cost, and constantly transparent.

But this is all just theory. To really see why full diversification is so important, let’s take a step back from that 2018 performance snapshot and look at it in fuller context.

A deeper kind of preparation

Here’s another chart that covers 2018 performance, but also shows five years’ worth of annualized net returns comparisons.

There are a few important things to note:

• No single investment was the best performer in every year recorded.
• With this data, an observer would not be able to predict any given year’s performance based on the performance of the year prior.
• Despite never reaching the single-year performance heights of the public stocks or public REITs, the year-over-year consistency of Fundrise’s platform portfolio resulted in meaningfully higher average returns over these five years.

In many ways, I think these numbers speak for themselves: the stock market’s more predictable characteristic is often its unpredictability. For many of the investors, the best investment performance typically comes from taking steady steps toward building a robust, balanced portfolio, one that operates as a calibrated, evenly weighted mechanism  — not from gambling with lucky market moves or attempting to time sales. Ultimately, the secret to cutting investment losses is generally in preparatory measures and access to diverse asset classes, not in knee jerk reactions and crossed fingers.

As Fundrise investments are designed for long-term investors, with investment horizons of five years of longer, the strongest portfolio diversification models will be those that can deliver the best returns across this timeframe as a whole, while establishing a strong foundation for future years too. That requires a deeper kind of diversification, one that can use an asset like private market real estate as a ballast against weak public market performance, but still harness those public market investments’ strongest years, when they are at their peaks.

And for investors who haven’t started building that sort of deeply diversified portfolio yet, preparation can start today, with no need to wait for the pressure and panic of a plunging market to make them feel cornered. If private market real estate is a diversification strategy that appeals to you, and you are interested in Fundrise, you can learn more about getting started and open your account here. That way, when the market has its next season of volatility, the work to establish your portfolio’s preparation and resilience will have already been done.

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