Many investors who manage their own money and their own investments have several tremendous advantages over fund managers. Investors who have bypassed the allure of the fund management industry often come to realize that through diligent research and logic, they can keep up with the returns of the big boys.
My investment business, albeit in the fund management profession, is run along the private investor’s lines. All of the advantages below are practiced by my fund.
While this may appear to be caused by superior market knowledge and over-confidence, there are in fact a number of advantages the small guy has. I advise all amateur and part-time investors to read over these structural advantages and use them to your benefit.
1. You can wait.
Private investors have the luxury of time on their side. If you cannot find anything attractive you can stay in cash. Fund managers do not have this luxury for two reasons. Firstly, they have to invest to their mandate irrespective of current market valuations (for example equity funds must have a certain percentage of their money in equities at all times). Holding cash in the fund is also a risky strategy for fund managers as they run the risk of being left behind by their peers, whom they are compared to on a quarterly, monthly and sometimes even daily basis.
2. You can invest anywhere and everywhere.
Without an investment mandate, you can invest in any type of asset in any country that offers an attractive risk return trade-off, be it corporate bonds, equities, options, real estate etc. As mentioned above, fund managers have to stay within the fund's investment area. In the case of pension funds, there are even more severe limits that, in my opinion, limit the returns the fund can provide.
3. You can invest in any size
Similarly to investing anywhere, there are no size constraints on your investment. Fund managers are faced with ridiculous restrictions as to how much to “weight” to certain indexes in order to match their performance as closely as possible.
4. You have no benchmark
You only have one goal in mind, and that is to grow your investment portfolio each year irrespective of what the market does. I do not consider it a good year if I have lost 25% while the market has lost 40%. Fund managers are groomed to beat their benchmark and this performance is always viewed in context, irrespective of absolute return.
5. You can focus and ignore
Studying, understanding and applying what has worked in investing is all you need to do to be successful as a private investor. I advocate reading Benjamin Graham classic, The Intelligent Investor. The rest should follow. Pay no attention to market noise, alternate opinions or what the television “talking heads” say. Do your own research and arrive at your own conclusions.
6. No conflict of interest
The individual investor has only their interest to look out for. This is a big advantage when it comes to large fund managers catering to larger institutions. Fund managers have to think of keeping their jobs, increasing their assets under management and keeping clients happy, suggesting that performance is not the most important thing on their minds. Also, clashes between investment banks and fund managers are regular occurrences and sometimes result in inopportune purchases by fund managers.
7. You can have a long view.
According to a study by the New York Stock Exchange the average holding period of shares held has declined from five to six years in the 1950s to 11 months, meaning the average holding period is less than one financial year. It is extremely unlikely and almost impossible that an undervalued company can right itself in such a short period of time. This may be the largest competitive advantage you have: The ability to look at a company solely on valuation and keep it as long as it is undervalued, irrespective of what the competition is doing or market price.
8. No peer pressure.
There is no pressure to buy or sell any investments. Fund managers get compared to benchmark indices and other funds, including the individual fund holdings. If you manage your own money you have none of these problems.
9. You decide.
The private investor is in control of all their decisions. You make the final decision after you have done the analysis. You may be wrong but at least you make the calls either way. Many fund managers are run by committee which leads to inherent clashes. Try telling your boss that his investment ideas are wrong!
10. You don’t have to di-worse-ify!
Every individual should hold only as many stocks as they feel comfortable with. There is no set limit either on the low or high end. However, most mutual funds hold positions in excess of 100 stocks. My business has only 7 positions. While I advise 10 as the optimal, we won’t buy stocks just because we hold seven and need ten!
11. You control the costs
Controlling costs and fees (the friction of investing), is a very important part of realizing superior long-term results. Discount brokers provide ideal services for the private investor, so long as you are not a day trader! Calculated over a period of 20 to 30 years keeping costs low makes a huge difference.
12. You can be fully invested
This is a huge structural advantage you have and is the bane of the fund management business. Fund managers are bound to get redemption requests when markets fall, and to meet such requests either need to be in cash or sell shares. However, as we have seen in 2008 in particular, when markets are falling liquidity drops, sometimes to the point where a fund manager is unable to sell his position. This results in selling pressure on stock prices leading to further market falls, thus triggering more redemptions, and so on.
There are of course a few funds where the drawbacks mentioned below do not apply but they are in the minority, my fund being one of those. The large bulk of fund management companies are focused on growing the amount of money they manage, while the performance of your portfolio is not the utmost concern.
If you do not want to manage your own investments then find a fund manager who is not bound by parameters and can show clearly that the performance of your investment is there foremost concern.
These pointers are an adaptation of an article written by Tim du Toit of Eurosharelab.com
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