Invest like an institutional investor
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Unlike individual investors that focus on the short term, institutional investors have a long-term view. Instead of focusing on buying or selling stocks to maximize returns, institutional investors focus on achieving investment returns in accordance with their future financial responsibilities. They normally remove emotions from investment decisions and make investments based on modern portfolio techniques.
Institutional investors, such as pension funds, have a very simple but disciplined approach that can be successfully used by individual investors. Their investment process can be summarized in 4 stages:
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1. Investment Policy Statement
First, they start with a written investment statement that defines their return objectives, risks and constraints (liquidity, time horizon, taxes, regulatory and any other relevant issues). This is the map that will guide investment actions and protect the investor from making trades based on emotions that originate from “market opportunities” that don’t really exist.
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2. Strategic Asset Allocation
Second, they define a strategic asset allocation that will help them accomplish the goals established in their investment policy statement. At this stage, they define the asset classes where they want to invest, such as equity, fixed income or alternative investments. They focus on investing in a diversified portfolio composed of asset classes that, statistically, move differently from one another. This is the most important part of the investment process because 90% of the return will come from asset class selection and the level of diversification.
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4. Monitoring and Rebalacing
Finally, they monitor and rebalance their investment portfolio depending on how it deviates from their strategic asset allocation. They do not react to short-term market movements; they have a clear plan that they stick to because any deviation from the original plan may put the payment of future financial obligations in jeopardy.
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