Is a Small Investor at a Disadvantage?


Ask SmallIvy

Certainly the professional has advantages.  He has a large budget to buy the latest research or even have a staff to perform independent research.  He may also own enough shares to be able to call the company or visit and get information about how the company is performing first-hand (Note that he will not get any insider information since it is illegal to disclose such information to outside parties – he may just get more attention by the officers due to the number of shares held).  He may also be able to get people on the board for the company.  He will also be able to buy and sell shares at lower commissions than the retail investor.That said, the small investor has some advantages over the professional managers.  The small investor is not beholden to other investors, and therefore does not need to try to beat the performance of other funds each quarter.  The small investor also does not have individuals buying or redeeming shares of his fund.  These actions, which usually occur at just the wrong times, force mutual fund managers to sell  or buy shares of stock at bad times in order to raise cash for redemptions or stay fully invested.

The most important advantage that the small investor has  is ironically due to the size of his portfolio.  Because the professional manager has billions of dollars under management he must buy several different securities in each sector.  If he tries to just buy his favorite he will drive the price up just from his purchase, resulting in the receipt of a poor price.  Likewise when selling he would drive the price downwards.  He therefore must purchase not just his top pick, but basically the whole sector.  This means that his performance will never be better than the market.

The small investor, on the other hand, can just buy the top picks in the sector.  His purchases and sales do not affect the price of the shares.  He can also hold the shares for long periods of time, avoiding capital gains taxes until opportune moments.  There is no pressure so sell shares because of redemptions that the mutual fund manager faces.

The small investor must take advantage of these advantages, however, through his investing style.  If one tries to time the market, jumping in and out of stocks, the professional with his advantages in lower fees and information will win out.  One would be better off just buying some low-fee mutual funds or index funds.  If the small investor buys for the long-haul and concentrates in only the best stocks in each sector, however, he can beat the market and the pros.

So if you wish to beat the pros, use your advantages.  1)Buy only the best companies that have good long-term prospects and 2)hold them until the fundamentals of the company change such that they are no longer good prospects.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. In addition the writer of this blog is not an accountant and writings should not be taken as tax advice which should be left to a CPA.  Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

About these ads

2 thoughts on “Is a Small Investor at a Disadvantage?

  1. “The most important advantage that the small investor has is ironically due to the size of his portfolio”

    Does the small investor sacrifice this key advantage when he she purchases a fund?

    Many thanks for your thoughts

    • Yes, when a small investor buys a mutual fund, he/she is giving up the advantage since now his/her money is pooled with that of thousands of others. When the mutual fund manager buys stocks, he may have billions of dollars to invest. This means he needs to buy not just his top picks, but virtually everything in the sector. Because mutual fund managers need to stay nearly fully invested (otherwise they lag behind when the market goes up), they end up buying a lot of things they don’t really want to own. Also, just moving into and out of a stock will push the price around, meaning the mutal fund manager is never going to get that good a price. Couple this with the fees, and the mutual fund investor will never do as well as the market, let alone beat it over long periods of time.

      That said, if you already have a lot of money, there is nothing wrong with using mutual funds as an easy way to diversify or as a one-stop investment, and a stock mutual fund will beat a money market anytime for long-term investing.

Let me know what you think.

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s