Q&A With Ric Edelman on the Technology Sector

The technology sector has long been a favorite among investors, representing more than 26% of the value of the S&P 500. More than 15% comes from tech’s Big Five: Facebook (ticker: FB), Amazon.com ( AMZN), Apple ( AAPL), Netflix ( NFLX) and Alphabet ( GOOG, GOOGL). But sky-high valuations and recent volatility may make savvy investors, especially of the value persuasion, pause. Can these FAANG stocks continue to grow?

We spoke with Ric Edelman, founder of Edelman Financial Engines, to get his perspective on the technology sector. He presents an argument for why investors should stay invested in tech — up to 15% of your total portfolio for most investors — and where to look for the safest options. Here are edited excerpts from that interview.

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What is your perspective on the technology sector today?

We’ve seen incredible growth in tech companies over the past 12 months. And it’s not the ordinary technology that people have grown accustomed to but new innovative technology that has not yet fully reached the marketplace: artificial intelligence, robotics, big data, 3D printing, nanotech, bioinformatics and other experimental technologies are going to add trillions of dollars to the global economy over the coming decade and revolutionize how we behave, how we consume goods and services, how we learn and even how we work.

What’s important is to recognize is these are long-term trends and too often investors are looking at the short-term prices, allowing current headlines or news to influence their buying and selling decisions. That’s what’s creating volatility in the marketplace right now, and it’s a distraction that investors need to avoid.

Investors are looking at quarterly results and the latest announcements from companies when they should be looking at long-term trends. A great example is the current shortage of computer chips, which is causing supply chain problems for the automotive sector. Add to that the disruption in March in the Suez Canal, which has interfered with supply chain delivery. It’s easy to consider both of these developments as bad news for the tech sector, but five years from now neither one of these facts are going to be relevant.

How do you suggest investors and advisors approach investing in tech in the face of such volatility?

If you are a long-term investor, meaning you plan to remain invested for years or even decades to come, then you can view volatility as a buying opportunity. If you liked the stock at $20 per share, you should love it at $10. That’s the exact opposite emotion most investors have. If the stock they love at $20 falls to $10, they react with fear and think they should sell. What you should recognize is that it represents a wonderful buying opportunity.

Today’s investors are also facing the opposite problem of what to do with a stock they loved at $20 that’s now worth $40. How would you address this concern?

This is the flip side where, instead of fear causing you to make bad decisions, greed now causes you to make bad decisions where people have the attitude of FOMO — fear of missing out — and YOLO — you only live once. What you should do is again exploit volatility. If a stock has doubled in value you should engage in rebalancing. When you bought the stock or the fund or ETF, you wanted it to be a certain percentage of your overall portfolio, say that was 5%. If it has increased so much faster than everything else and is now 10% of your portfolio, you need to sell half of it to bring it back to your original intent of 5%.

When you rebalance in this way you’re selling your winners and protecting your profits, then using these profits to reallocate to sectors that haven’t risen so much, enabling you to sell high and buy low, and that’s a strong combination for long-term success.

Why should people stay invested in tech despite its high valuation and volatility?

Even companies that manufacture traditional products are using tech in innovative ways to operate and grow their business. There’s hardly any product less high-tech than pizza, yet Dominos Pizza ( DPZ) and Pizza Hut both get more than half their sales from online ordering. You can track the production of your pizza and the delivery of your pizza with an online app. You can order your pizza with your Xbox. These companies are using technology in innovative ways to improve the customer experience. So you can either invest in pizza companies or you can invest in the technology companies that help those pizza companies succeed. Frankly, you should do all of the above as part of a diversified portfolio.

[Read: Q&A: Improving Tax Efficiency in Investor Portfolios.]

What are the risks of investing in such rising technologies?

There’s no question that innovative technologies are at a higher level of risk. This is why diversification is important and why the ETF approach is a better approach than buying individual stocks. Let’s keep in mind that 100 years ago there were 200 automobile manufacturers in the U.S. and today there are three (major companies). In 1945 if you came out of aviation school, you would have either gone to Eastern Airlines or Pan Am. Today the aviation industry is much bigger but both those companies are gone. It’s better to be correct (directionally) than to attempt to be precisely accurate by picking specific winners. Investors should focus on broader sectors and industries rather than individual companies.

Are there any particular tech stocks you’re loving right now?

In our practice, we use ETFs that are investing in cybersecurity and robotics and AI, biotech, fintech and the Internet of Things. I’m a big fan of Global X, the Blackrock iShares Exponential Technologies ETF ( XT), State Street’s Kensho Funds and Invesco.

What guidance do you have for advisors whose clients may be overly enthusiastic about tech right now?

Advisors have the challenge of helping clients avoid becoming overenthusiastic. Clients are often their own worst enemy, and it is the advisor’s task to help the client stay focused on their goals as opposed to being focused on the market. When you stay focused on your goals you often realize you don’t need to have as big of an exposure to a given asset class as you thought, and that helps you remember the importance of diversification.

People are investing in tech because they think they can earn dramatically higher returns than other investments. But do you need to achieve those returns to achieve your goals? If you can achieve your goals of financial security with a 7% return, why invest to earn 15% when trying to earn 15% might cause you to lose 15%? We all love that airplanes are faster than cars, but if you’re only going across town a plane is not nearly as effective as a car. Sometimes walking is the best method of transportation depending on your goals.

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Q&A With Ric Edelman on the Technology Sector originally appeared on usnews.com

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