Friday, September 16, 2016

Your advantage as an individual investor

Individual investors often get a bad rap. They are thought of as lemmings moving in and out of the market. In fact you have a number of advantages over the pros.
I was reading an article recently suggested that individual investors by and large have missed much of the rise in equity markets. Apparently retail investors reduce equity allocations when things are tough and increase them again as markets peak. Talk about buying high and selling low!.
Of course, this isn’t entirely true. Most of us have some amount of holdings in 401k’s and IRA accounts that have some stock allocation. This portion of your stock investments should have enjoyed a nice amount of appreciation over the last 7 years, even if you reduced your allocation of individual stock investment.
In any case, retail investors are possessed with more natural advantages investing in stock market than what they may believe.

In my view the biggest advantage that you have as a individual investor over professional money managers is time. Time to watch a business grow and compound in value.  Time to watch a business shrewdly reinvest  capital into additional growth opportunities to return multiples of your original investment. This is a really underappreciated advantage that institutional investors just don’t have.
Most institutional investors are on the clock. They are forced to chase performance, constantly looking over their shoulders to make sure no one is gunning for them. Apart from a select few funds such as Berkshire Hathaway, annual performance returns tends to drive their investment decisions. Lagging one year or three-year performance is seen as a sign to the market that these funds should be dumped.
Institutional investors and fund managers with lagging performance often see dramatic fund outflows hence it’s crucial for them to be the hottest stocks at any point in time.
That often means that they don’t have the patience to wait for a deep discount in value to be realized. They’re unable to wait patiently to see an investment thesis come to fruition in time frames longer than 6 to 12 months. The biggest issue of all for an institutional investor is they often have to take profits in highly performing stocks to offset losers that they otherwise have and show net performance gains over anytime.
Individual investors aren’t forced to chase short-term performance. There is no imperative on individual investors to sell out big winners to show paper gains. The fact that retail investors do this speaks to a desire to take profits and the lack of patience in a longer-term thesis playing out.
By and large manage funds also have arbitrary position and sector limits that limit position sizes. This also creates the need to trim positions if they become too large relative to the rest of the portfolio.
One of the biggest advantages that individual investors have is the ability to add small-cap and mid-cap stocks at will devoid of requirements around portfolio weighting.
As a practical matter most funds can’t buy enough of the small or midsize stock to dramatically alter their fund performance. They would need to buy too much of a company to move fund performance in any meaningful way. As an individual investor, a strongly performing mid cap company can make a significant difference in performance.
One of the biggest advantages that individual investors have over the pros is that they are by and large in control of their own destiny. Surprisingly, this isn’t  something that the pros have.
In fact, pros often have little choice but to buy high and sell low. Sounds counter intuitive? The reason for this is surprisingly simple. Investors in manage funds are motivated by rising prices. They flood managed funds with new money when markets move up, and hit up managed funds with redemption requests when performance is bad.
So what does this mean, practically? In order to maintain desired equity weightings, fund managers have no choice but to invest the excess money that comes in when stock prices are rising, and conversely have to sell stocks to fund investor redemptions when stock prices are falling.
In his excellent book, One up on Wall Street, Peter Lynch writes of his frustration in being unable to invest in down markets due to investor redemptions requests requiring him to sell stocks to meet investor requests to withdraw money. It was exactly the opposite of what he typically wanted to do. Conversely, a flood of new money at market peaks meant a need to buy at tops, when stocks were overvalued.
With a little bit of patience and a little bit of discipline individual investors can do far better than many funds with respect to managing their own money. The ability to persist with strong winners and hold them for long periods of time without market pressures to take profits are all advantages that most funds don’t have.
The ability to form a thesis and be prepared to wait a couple of years while it plays out is also a luxury that most profession investors don’t have. In fact, the simple ability to buy low and sell high seems to also be a very significant advantage over the pros!
A better appreciation of the advantages that individual investors have compared to other institutions in managing their money should inspire more investors to take control of their own destiny

This article was written by Financially Integrated. If you enjoyed this article, please consider subscribing to my feed.


Post a Comment

Recent Posts From DIV-Net Members