The Biggest Advantage for Individual Investors
People love to explain why you, a retail investor, can’t beat the stock market. They’ll bring up efficient markets, HFTs, algos, quants, smart-beta, pretty much anything to convince you buying common stocks is a fruitless endeavor.
And they can be right. If you don’t care about investing or don’t want to put in the time researching businesses, then buying ETFs and index funds are the way to go. It also might look like the odds are stacked against you. In the last 15 years, 92% of active managers failed to beat the returns of the S&P 500, a severe underperformance that has led to an exodus (and rightly so) from mutual funds.
But you aren’t a mutual fund.
Mutual funds have two distinct disadvantages compared to a retail investor. One is pretty obvious: fees. Active managers typically charge more than their passive counterparts (ETFs and index funds), meaning they have to perform better than them just to stay competitive. You don’t have to worry about this. In fact, with the ubiquity of commission-free trading and fractional trading going mainstream, you actually have a tremendous advantage from a fee perspective versus mutual fund managers.
So, outside of fees, what is the second and arguably most important advantage you have over Wall Street? A long-term time horizon.
Use Time to your Advantage
As an individual, you have no outside investors. Nobody is calling you after one bad quarter saying they’ll “pull their money out if you don’t turn it around soon!” (that’s more of a hedge fund example than mutual, but I think you get the point). You and only you are in charge of the retirement account, unlike a lot of the money on Wall Street. Make sure to use it to your advantage.
Patience and a long-term time horizon are underappreciated qualities of the best investors. From Warren Buffett to the Motley Fool to some of the individual investors I’ve had the chance to interview like Austin Liebermann and Matt Cochrane, market outperformance tends to come from buying quality companies and being patient. It sounds simple, but, trust me on this one, it takes major restraint and a rules-based approach to implement a successful buy-and-hold investing strategy.
Active managers can’t afford to take a decade-long approach to their investments. One down year and investors will start pulling money out of the fund, forcing managers to invest in a time-constrained manner. This is a big psychological factor in mutual funds becoming “closet indexers,” which is when they charge high fees for what is essentially an index fund.
As an individual investor with no outside pressure, you don’t have to worry about short-term headwinds for a stock and what it will do to your quarterly performance. Quarterly performance doesn’t (or, at least, it shouldn’t) matter to you. That is how individuals like you can beat the market.
All that’s left is finding quality businesses to own. But that’s another post.
Disclosure: The author is not a financial advisor, and may have an interest in the companies talked about.