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One of the best investing lessons I ever learnt from a book

One thing I often read about is that most private investors tend to underperform the overall stock market. Indeed, many even lose money with their shares rather than making it.

The problems include buying and selling shares at the wrong times, as well as picking poor investments in the first place. But private investors aren’t alone in their lack of stock-picking prowess. Most professional investors and fund managers are pretty rubbish at the activity as well, it seems. Although, in the wake of the Woodford Funds car crash, that statement probably doesn’t sound as shocking as it ought to!

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But still, they make money

Yet investors do go on to make millions even when displaying a poor share-picking record. How do they do it? I recently read an interesting book that reveals some insights. It’s called The Art of Execution by Lee Freeman-Shor. But don’t be alarmed. The solution to effective money-making in the markets isn’t as dark as the book’s title suggests – you don’t need to bump anyone off!

Freeman-Shor worked as a fund manager for Old Mutual Global Investors and the firm set up a Best Ideas fund, which he managed, with the idea of employing the best and most financially successful investors in the world. The idea being that the top investors’ best share ideas would surely make money from the stock market. Each investing Top Gun was given between $20m and $150m to invest on the strict understanding they could only pick from the 10 stocks that represented their very best investing ideas.

For seven years between 2006 and 2013, Freeman-Shor monitored 1,866 investments representing a total of 30,874 share trades made for the fund by 45 of the top investors on the planet. And, in his own words, Freeman-Shor was “shocked” by what he discovered. It turned out that just 49% of those top investors’ best share ideas made money. Worse still, some of them were only successful with their picks around 30% of the time.

But despite displaying stock-picking ability falling below that of someone making decisions based on the toss of a coin, nearly all those well-heeled investors went on to make money from the stock market – a lot of it. How did they do that?

Executing your portfolio effectively

It’s all about how you manage your portfolio after you’ve filled it with shares. Many of the share prices went against the investors in the study, and Freeman-Shor said in the book that, in cases like that, you have to take decisive action. He suggested either cutting your losses and selling out of the share before losses become too large, or averaging down and buying more. I disagree with averaging down because I reckon that’s a risky strategy. But cutting your losses is a good idea, in my view

And to overcome portfolio losses, Freeman-Shor advises us to run our winners. Most investors tend to take profits too soon and sell out of winning shares. But the super-investors contributing to his fund’s performance made millions by allowing the winning investments to remain in their portfolios for a long time.

We can make a portfolio perform well by executing well, despite poor share-picking. That’s one of the best investment lessons I ever learnt from a book.

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Kevin Godbold has no position in any share mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.