Investing in technology can be very alluring.
For starters, there's the dream of making a massive profit on just one investment. If you can spot a tech giant of tomorrow when it's still a minnow, it can make you rich. If you had invested $1,000 in Microsoft shares in 1985, they would now be worth $450,000. And that's not including dividends.
Sure, most of us won't ever make quite such a lucrative call. But with the pace of technological change moving so quickly, it feels like there must be money to be made.
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On the other hand, tech investing can be very risky. It's all too easy to end up with a portfolio stuffed full of rubbish stocks that have either gone bust, or have long since failed to live up to their early promise. I've done it myself.
So here are three tips on how to avoid the biggest pitfalls.
Why tech investors need to look beyond Britain
Imagination Technologies (LSE: IMG)
Above all, that means the US. Silicon Valley is the still the world's technology hub and you'll find many more great tech businesses in other parts of the US, especially the North East.
Secondly, don't ignore the giants of the sector. It's easy to look at established tech businesses and assume there's no point in joining the party now. Surely the big profits have already been made?
But I think that's a big mistake. Look at Apple. It's true that the company has fallen on tougher times since the death of founder Steve Jobs. But it's also easy to forget that just three years ago, its shares were trading at $290 a throw. Now they're around $470 and have been much higher.
The iPhone had been on the market for three years by September 2010, so you hardly needed to be a brilliant diviner of tech trends to spot that Apple shares had potential at that point. So investing in tech giants when they're already giants can still make you a good profit.
Which raises the question: which giants should you invest in right now?
However, Google also has a $50bn cash pile and profits are growing fast. It has achieved a dominant position in web advertising that's hard to challenge. What's more, Google is also investing in several moon-shot' technologies such as self-driving cars or wi-fi balloons.' So with Google, you can own a tech giant today, and there's a small chance you'll profit from new technological breakthroughs tomorrow.
I'm also a fan of Amazon (Nasdaq: AMZN). Yes, it looks very expensive on traditional valuation metrics a p/e of over 100 is always going to look scary. But Amazon has never looked cheap. And in its favour, the company has a successful track record of aggressively reinvesting any cash it generates and growing extremely fast as a result. Amazon has also perfected the art of inflicting serious damage on any rivals via very aggressive pricing.
As for Qualcomm (Nasdaq: QCOM), I think it's a great way to play the smartphone boom. You could spend days agonising over whether Apple can successfully maintain its chunky margins or you could just take the simple approach and go for Qualcomm. The company designs and manufactures a wide range of products and technologies that are all related to the mobile world in which we now live. And it's held by several leading technology funds.
This is one sector where fund managers can earn their keep
Because technology is by its nature complex, this is an area where active fund managers can add value. Perhaps more importantly, a fund is a good way to diversify your exposure (and thus reduce the risks) across a range of stocks in the sector.
I'll highlight two tech funds in particular. The MFM Techinvest technology fund has an outstanding track record and has beaten all its rival tech funds over the last five years and one year too.
The Polar Capital Technology Trust (LSE: PCT) is also worth a look thanks to its experienced management team. It currently trades at a discount to its net asset value of around 7%, so in effect you are getting £1-worth of assets for 93p.
One final point: I've put a lot of emphasis on reducing risk by investing in tech giants and tech funds, but I'm not ruling out all investments in smaller fry. Once you have a core portfolio in funds or giants, you can afford to take more risk on the edge with some younger companies or brand new technologies.
So, for example, you might want to look at 3D printing which has the potential to be absolutely massive. You can read more about this area in our recent article: 3D printing: the dawn of a new industrial revolution.
Or if you are keen to invest in individual high-tech stocks, you should really take a look at my colleague Mike Tubbs' newsletter, Research Investments. Mike focuses very specifically on technology companies that invest a lot in research and development, and staying ahead of the competition.
Whatever you do, don't ignore technology. I think all long-term investors should have a sizeable allocation to tech stocks in their portfolio. After all, it's an area where growth is almost inevitable - and that will remain true regardless of what economic turbulence we see in the next few years.
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Ed has been a private investor since the mid-90s and has worked as a financial journalist since 2000. He's been employed by several investment websites including Citywire, breakingviews and The Motley Fool, where he was UK editor.
Ed mainly invests in technology shares, pharmaceuticals and smaller companies. He's also a big fan of investment trusts.
Away from work, Ed is a keen theatre goer and loves all things Canadian.
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