Why it’s a great idea to learn how the stock market works.
Since the tech stock blowup of ’99/’00, there has been a consistent flow of banter online and in financial news about the rise of the individual investor, the poor odds for success against the big guys and further details of doom and gloom. To be frank, it’s primarily noise.
After you’ve been investing for a little while (even less than a year), you’ve heard and seen enough to know that the odds of success for the little guy just aren’t that great. That horse gets beat pretty fast and pretty consistently.
In light of all the warnings, the number of individual investors continues to increase. Recent research from Nasdaq shows that more individual households are starting to invest their own money.
Given this reality, the most useful information seems to be how can individual investors succeed without buying an index. Very few professionals investors actually index. Professional investors are primarily purchasing stock directly in companies and running pretty concentrated portfolios (the average number of positions seems to hover around 15), yet the mantra of ‘just buy the index’ for retail investors is pretty popular.
There’s nothing wrong with indexing but it’s not something that everyone wants to do. The thing 99% of retail investors want to know before they either quit trying or cave in and buy an index, is if there’s any way to succeed and pull off outstanding returns that outperform the S&P 500 (without switching over to more volatile assets with much higher risks, like crypto or commodities).
The answer is yes: but, you have to know very clearly where to fish. The stock market can be divided into several ponds distinguishable by things like the current market cycle, market cap size, mergers / acquisition targets or distressed debt instruments. Each of these pockets attracts investors of different goals and styles.
Not all ponds are created equally for the individual investor but very few people discuss this important truth. It’s a key insight that many individual investors just don’t hear about or understand how to fully exploit. Instead, people are told to just index for their own “safety” as to not get “hurt.” That’s one way to live life.
The advantage of being a individual investor, which many people wrongly believe is a disadvantage through repetitive messaging around this idea, is that individual investors don’t have millions or billions of dollars that need to be invested (like large hedge funds or mutual funds) so they can play in a more attractive pool for their capital. As Warren Buffett remarked, a fat wallet is the enemy of high returns.
Retail investors are at the greatest advantage when they’re a tiny fish in an initially quiet pond that expands exponentially after they arrive. Big ponds with buzzing activity (think Apple, Microsoft, Tesla) are for large hedge funds and mutual funds/401Ks. This is especially true if an individual investor does not yet have the capital to purchase enough shares to make the investment worth their while in the event that the share price trends upward. How would one share of Amazon significantly change an investor’s financial life, even if they held it for a decade (which is pretty optimistic since the average timeframe that most investors hold a company tends to be between 5 and 8 months)?
Most individual investors have no business swimming in the big pond until their portfolios have performed so well that they can no longer invest in the small ponds anymore, which is a great problem to have. It’s a problem that smart investors eventually develop although the mechanics aren’t often discussed. Several great investors like Buffett, Joel Greenblatt and Mohnish Pabrai started out in these types of ponds and then primarily switched investment styles when they had too much capital to invest.
Why do individual investors end up fishing in the wrong pond? This happens because 1) they don’t know what they don’t know, 2) many individual investors lack a simple understanding of how markets can work for them and 3) many don’t know where to get started with a workable process. Unfortunately, more information also doesn’t necessarily trigger a change in behavior. Some investors are comfortable doing what they’ve always done even if it doesn’t work that well. For these types of investors, losing money isn’t painful enough until they’ve lost way too much. Smart investors avoid this pitfall by all costs even if it means dealing with some short term underperformance in the market.
At Simple Investing Success, we continue to work on pushing out useful data and powerful insights to help more individual investors jumpstart a lucrative investment process. As an individual investor, you have to know very clearly what your process is and why you’re doing it.
Make sure you have the right investment edge working in your favor.