Professional investors don’t always generate huge returns. However, generally speaking, they tend to generate much higher long-term returns than retail investors do (studies have shown that many retail investors make less than 5% per year on average).
The good news is that, thanks to advances in technology, anyone can invest like a pro today. With that in mind, here’s how to invest a Stocks and Shares ISA like one.
Pros like high-quality stocks
Professional investors like to invest in high-quality companies.
I’m talking about companies that are growing, are highly profitable, and have strong balance sheets (a good example here is tech giant Microsoft).
Why do they like to invest in these kinds of companies? Because these businesses tend to be more stable investments. And for a professional investor, stability is crucial. For a start, these investors are in charge of managing other people’s money, so it’s imperative that they don’t rack up large losses. Secondly, they could lose their jobs if their investment performance is poor.
Of course, valuation is often an important factor for professionals. So, they’ll often wait patiently until a stock’s valuation is reasonable (not necessarily low) before investing in it.
Managing risk
Once they’ve identified a number of high-quality companies trading at reasonable valuations, pros will diversify their capital across a range of securities to minimise stock-specific risk.
Now, there’s no exact number of stocks one needs to have to be well diversified. But you rarely see a professional investor who owns less than 20 stocks in their portfolio (many prefer to own 40-60). By owning 20 stocks or more, one can reduce their stock-specific risk significantly.
When diversifying, they will pick stocks from different sectors (and different countries if they’re managing a global portfolio). This will help to reduce risk further.
Most professionals don’t allocate the same amount of capital to every stock in their portfolio, however. Instead, they will ‘right size’ their positions.
What I mean by this is that they’ll allocate more money to lower-risk stocks and less money to higher-risk stocks.
This is another classic risk management strategy. And it can help investors avoid big losses.
I think right-sizing is a key reason pros tend to outperform retail investors. Quite often, you see retail investors with portfolios that are heavily skewed towards more speculative stocks. Most professionals would never do this, as they know it’s too risky.
Taking a long-term view
Now, professional investors often hold on to their high-quality stocks for the long run (they understand that winning companies can keep winning for decades). However, they may engage in some tactical trading at times. If a stock gets a little expensive, they might take a little profit off the table. Conversely, if the stock becomes cheap, they might buy some more of it.
Finally, pros tend to remain invested throughout market cycles and volatility. That’s because they understand that time in the market is more important than timing the market.
The post How to invest a Stocks and Shares ISA like a pro appeared first on The Motley Fool UK.
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Edward Sheldon has positions in Microsoft. The Motley Fool UK has recommended Microsoft. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
