You’re an Individual Investor? Exploit Your Advantages to Beat the Institutions
Yes, you have advantages. If you have patience and intelligence, you have the potential to be as good as anyone.
I bristle when I read accounts – usually forwarded by professionals with a monetary stake – that investing is too complicated for the non-professional. “Leave it to the pros,” they reason. “After all, you wouldn’t perform surgery on yourself.”
No, I wouldn’t perform self-surgery, but I attend to health through nutrition and exercise, as every adult should. I attend to adult responsibilities. I suspect for these reasons, I haven’t needed a surgeon’s services.
Managing finances is an adult responsibility – one every adult must undertake. What’s more, managing your investments – choosing your own investments included – is within the capabilities of any intelligent adult. Thanks to the Internet, tools to self-educate (what you are reading, for instance) are readily available. Initiative is key.
Best of all, the market favors the individual investor. Yes, you hold a number of advantages over the professional you likely haven’t considered. Five spring immediately to mind.
Expense Control
When you pick your investments, you control expenses. Most online brokerages attach no commission for trading stocks. And when you own the stock, you incur no additional expense. Actively managed funds frequently charge 1% to 2% annually of money under management. Some even charge sales loads, which can range up to 5% of your investment.
If you are sufficiently wealthy to invest with a hedge fund manager, expenses ratchet up exponentially. Many hedge funds take 2% of money under management annually and then skim an additional 15% to 20% above a certain performance goal.
You can pay dearly for someone of some renown to manage your money. Why not replicate it and save a few bucks?
Bill Ackman, a celebrity investor and chairman of Pershing Square Capital Management, runs a tight ship with his stock investments. He owns only nine at the last report, which was dated March 31. Here are the nine stocks and their respective market weights in the portfolio:
Lowes (NYSE: LOW) 19.7%
Chipolte Mexican Grill (NYSE: CMG) 17.3%
Restaurant Brands International (NYSE: QSR) 16.0%
Hilton Worldwide Holdings (NYSE: HLT) 12.9%
The Howard Hughes Corp. (NYSE HHC) 12.0%
Canadian Pacific Kansas City Railways (NYSE: CPD) 11.6%
Alphabet/Google (NASDAQ: GOOGL, GOOG) 10.6%
Pershing Square charges a 1.5% annual fee. It also collects a performance-based fee, which starts at 16% of the increase in net asset value (after the management fee and other losses have been deducted). You can replicate the core portfolio on your own. You won’t be privy to real-time sales or purchases and you won’t be privy to short-term derivative hedging strategies. But you’re a long-term investor, and Ackman tends to hang around for a while with his picks.
I’m neither endorsing Ackman’s strategy nor recommending his investments. I’m letting you know that the information is easy to find and replicate, if so inclined.
TAX MANAGEMENT
When you fly solo, you choose when to book your profits or take your losses. You need not be goaded into action by the whims of others, as mutual fund and ETF managers are goaded. You’re not forced to accept a tax liability imposed on you from above by a fund manager.
(If you own a mutual fund with a high turnover ratio outside of a retirement account, you know what I mean. Your fellow fund investors panic in a market sell-off, and the fund manager is forced to pare the portfolio to meet redemptions. If the holdings sold had appreciated over the holding period, you get stuck with a tax bill, even if the value of your portfolio was down for the year.)
You, as a sovereign, knowledgeable investor picks when, where, and how long you invest. Professionals buy and sell with no regard for the individual investor. Constructing your portfolio puts you in charge of taxes. The more you can minimize this dreadful toll on living, the more money you can invest, and the more wealth you build over time.
IMPERATIVES
Speaking of time, you have the freedom to let it work for you. You’re under no pressure, like the institutional money manager, to beat a benchmark every 90 days. You have the luxury of holding whatever you want for as long as you want. You can hold stocks that temporarily lag the market (as all eventually do) that hold the potential for outsized gains or hold stocks with the prospect of dividend growth down the road.
With no institutional imperative driving your decisions, you have direct control over your wealth. You can invest as little or as much of your money as you want or you can simply hold cash. No faceless competition forces your hand to do something ill-timed or just plain stupid.
I suspect that time — ill or otherwise — is an issue.
A few years ago, LPL Financial produced a report that revealed the average holding period of an NYSE-listed stock. This should come as no surprise, the average holding period has trended down through the decades.
LPL’s research showed the average holding period at just over eight years in 1960. A decade later the average holding period had been reduced to just over five years. By 2010, the average holding period had been emaciated to six months.
A good deal of this time compression is attributable to the rise of institutional trading, which includes frenetic high-frequency trading. That said, if I were to hazard a guess, I’d guess that most individual investor holding periods have trended with LPL’s research. (A meaningful individual average is difficult to conjure, as the data required to calculate the average are difficult to gather.)
This inability to stay the course is problematic. As Warren Buffett trenchantly observed (and when does he observe anything but trenchantly), “Successful investing takes time, discipline, and patience. … You can’t produce a baby in one month by getting nine women pregnant.”
I concur with Buffett, though to his observation I’d add that successful investing also requires the right investments.
KNOWLEDGE
Yes, the individual has a knowledge advantage. Economist John Maynard Keynes offered insight into this advantage ninety years ago. Keynes observed, “The dealers on Wall Street could make huge fortunes if only they had no inside information.”
Inside information appeals to the vanity of exclusivity: I have something you don’t, and that elevates me a level above you. We all want to feel superior. We all believe we are above average. The world is Lake Wobegon in total. Inside information emboldens that feeling. But as it is so often in life, inside information isn’t necessarily the right information, nor will it necessarily invoke the response you expect once it’s publicly disseminated.
This psychological craving for exclusivity is the reason the word “Secret” appears so frequently in marketing copy. Secrets? There are no secrets to successful investing, weight loss, relationships, or business development. Your ignorance isn’t a corollary to someone else’s “secret.” If your dentist says that he has a “secret” to relieve your toothache (a root canal followed by capping the tooth is the secret), you would think, “Cut the crap and fix the tooth.”
The “secret” to success, investing or otherwise? Here you go: discipline, tenacity, persistence, knowledge and wisdom (because knowledge is useless without wisdom). In other words, embrace the grind and endure the pain, and do it consistently. If that’s a secret, it’s the most ancient, ubiquitous secret on record.
(Non-Sequitur: Exclusivity is the great appeal of wealth. Wealth enables one to separate one’s self from the mass. Wealth opens the possibilities of secluded estates, private jets, yachts, pristine beaches, and exclusive hotels. Wealth enables us to interact with other people on our terms. And more often, we prefer to distance ourselves than to engage. We are more likely to find people disgusting than enchanting. These are the reason we hate waiting in queues and sitting in economy class. They are the reasons poverty advocates spend as little time with the poor as needed. Bill Gates is willing to give the poor all the vaccines they want, but I can assure you he’s unwilling to spend time with them. The proverb “Good fences make good neighbors” has endured in various iterations for centuries for a reason.)
To Keynes’ insight on inside information, I’ll add the stultifying effect of too much information. A constant bombardment of news, innuendo, and rumor within a clustered world compromises intelligent thought. Separating fact from fiction becomes more difficult. As an individual, you can easily distance yourself from the noise. To improve your decisions, sometimes all you need is a little quiet contemplation.
SIZE
Size matters, and the smaller you are, the nimbler you are. Most individuals can buy and sell a stock with no worry about moving the share price. In contrast, institutions frequently must invest millions of dollars in one stock. They must carefully parse the trade to avoid the share price moving against them.
More importantly, the universe of publicly traded stocks is much larger for the individual. As size grows, the universe shrinks. Warren Buffett and Berkshire Hathaway (NYSE: BRK.a) consider only investments that can absorb billions of dollars — a very small universe. You, as an individual, can consider any investment that absorbs only thousands of dollars — a very large universe.
Human nature magnifies the perceived omniscience of celebrity. The oft-quoted celebrity is viewed as the incontestable sage. Self-deprecation is the corollary to this tendency to magnify celebrity. We underestimate and belittle our own abilities. At the same time, we disregard our natural advantages. Don’t. Investing isn’t dentistry, after all.
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