Doesn’t look good right? It looks like the probabilities are stacked against a private investor according to many analyses.
But look at the great investors; Peter Lynch, Warren Buffet, David Tepper, Terry Smith, to name a few, they were able to beat the market.
Were they just lucky?
Or in the right place at the right time?
Or was it skill?
That is the debate that rages over the dinner table in every part of the globe.
But, I have not seen any analysis or statistics on private investors vs fund managers. It simply cannot be done as it would be too complicated. Certainly, we have data on stats on traders losing all their money, but stock investors are a far more secret world.
What about successful private stock investors, can you name a few of them? Probably many of these individuals keep their returns to themselves.
You can however find evidence on Twitter, of people beating the market. This is what got me involved in investing, as I saw >20% annualised returns from Saxena Puru and others.
In fact, my returns have beaten the market so far by following a few people on Fintwit, learning what makes a great company, and developing my own process of investment.
So let’s look at, what possibly gives the retail investor an edge and why many fund managers and hedge funds fail to beat the market:
1) Size advantages
First funds struggle to execute their strategy as they grow (fund elephantiasis): often a fund will start out with stellar performance, but as it grows it finds its opportunities reduce, because the size of the investment is much greater, for example, Berkshire Hathaway.
Early on Berkshire went from a small insurance company to a global conglomerate now worth >$500 billion, generating superior returns for investors. But over the last 10 years, it has failed to beat the SPY.
Often us retail investors don’t have that problem because our funds are smaller and therefore our opportunity set of investments is greater. We can invest in smaller market cap companies more easily.
2) Diversification
Now, this is a grey area for the retail investor edge.
I’ll explain why.
Diversification is used to reduce risk in a portfolio. Higher diversification lowers risk, but also potentially lower returns (but not always, depends on the portfolio).
And the opposite can often be true, higher concentration, higher risk (but not always depends on the investments), and higher potential returns.
Now, what does risk mean?
Is higher risk, higher volatility?
Fund managers want to keep volatility and drawdown as low as possible to avoid investors freaking out and exiting out of the door.
This is one of the key retail investor’s edge.
Learn to stomach volatility and hold the fastest growing companies to generate better returns than the index.
As much as investment professionals would have you believe volatility does not equal risk. Permanent loss of capital is a risk.
Avoid losing your capital where ever possible.
Develop a due diligence process to select only high-quality companies, to reduce your chances of permanent loss of capital.
But look at some of the outperforming UK funds that have concentrated portfolios. The Scottish Mortgage Trust which has consistently beat the market has 85% of its funds invested in 37 companies and 48% in its top 10. Its bet on Tesla paid off and 2020 was a big year for outperformance.
Terry Smith’s equity fund which is beating the market also has a concentrated portfolio of 30 investments.
Maybe these funds point to portfolio concentration as a successful method?
As retail investors, we don’t have to answer to anyone, no quarterly performance reviews, or having to attract additional funds by pitching our performance and low drawdown. Although, possibly we have to justify a monthly investment budget with our wife or our family.
Therefore, we can run a concentrated portfolio of 10-30 holdings if we want. We can get a higher return for higher risk. There is no risk manager looking over our shoulder.
Of course, back your favorite ideas with a larger percentage of your portfolio if you have high conviction. That's your choice. That's your edge to play the market.
The counter to portfolio concentration is the higher risk of an investment not working out and causing a higher drag on returns. So bear this in mind. That is the skill.
Same reason we should avoid loss of capital as large drawdowns require larger returns to make those returns back.
Investment funds generally stick to one type of strategy, they are an emerging market fund, a small-cap fund, and have a specialism. Whilst a retail investor can hold many different types of stocks. You have the flexibility that a fund does not. Large-cap, small-cap, alternatives, etc.
Just focus on compounded gains and you will win.
Personally, I aim for a portfolio of 15-20 stocks and have higher amounts ~10-15% in my highest conviction ideas. But this of course is a personal choice and everyone is different in their preferences.
3) Long term thinking
Fund managers move firms, fund managers retire, fund managers die, fund managers need to produce short term results and they need to attract business so they need stable consistent returns.
Many of the reasons why funds underperform over the long term.
So we have a major advantage in that we can think long term and don’t have to get our yearly performance up or drawdown low.
Often times our investments will do nothing or even underperform and then accelerate to outperformance.
We will stay with our investments a long time and maybe even until we die, so that’s our edge.
All we need to do is pick growing companies and hold them for the long term to allow for compounded returns from reinvested profits.
That may be over 5, 10, or even 20 years.
So you must think long term as that’s where the best returns come.
Just look at Starbucks, MasterCard, and Home Depot amazing returns over 10 years.
In the words of Terry Smith:
Invest in good companies, don’t overpay and do nothing.
That is how the money is made.
3) Performance fee edge
You get to earn every penny of performance you generate. 1-2% is usually paid out to a fund manager and hedge funds can take even more.
Over the long term, this can be worth thousands of $$$ and can hit your returns. So you get an instant performance boost when you take the DIY route.
The key retail investor disadvantages:
Number one from my point of view is confidence in your analysis and decision-making. Money is an emotional topic for most people and is the place of lots of misguided thinking. Therefore fear and greed can affect our behavior which hurts performance.
No risk manager, no colleague to discuss an investment decision with can often be a big disadvantage.
It’s not easy to get around emotional decision making, you need to protect yourself from doing something rash. Often having a framework for decision making can help, but often such decisions are a balance of probabilities so a rigid framework does not always work.
But live through pain and experience and you will come out stronger. There is only one way through fear and greed and that is straight through it. It’s taken 10 years to overcome my emotional decision making around money. I am not perfect but much better than I used to be. It can be done.
Things that can help are letting your winners run.
Keep your best investments, add more money to them and don’t sell too early.
Often the best stocks are always at their highs, which is challenging because you naturally want to trim or sell to take profits.
You think it can’t go any higher, but often because of the way compounding works the best businesses can go many thousands of percent. Just look at amazon an investment of $1000 in 2009 at a share price of $58 would have netted you 5662% (or 56 times your money: $56,000).
All along the way the stock was at its highs and people calling it overbought and overvalued. Yet there was nothing to stop this juggernaut.
Seems unreal, right? Yet people made fortunes from one stock.
Examples like Amazon don’t come around every day, but you should focus on the concept of holding winners and they will eclipse your failures and mistakes.
You only need a handful of large winners in your career.
You just have to hold for the long term
Every investor has an experience that haunts them and promises never to do it again.
I have two: Bitcoin and Tesla.
I bought 2 bitcoins at $1000 (now $37k) and got rid of my Tesla shares way too early.
This pain of missing out causes me to refine the process for selling which involves adding into winners and leaving losers well alone.
You never know when they will come back. I do sell if there is fraud or an underlying reason, but 80% of the time I just hold the investment.
My new motto is:
Slow to buy through due diligence and conviction building and even slower to sell.
Time and information
Services like Motley fool or a select few on financial Twitter can help find opportunities and provide investment ideas, but you need to find your style and process. Take time to develop your skills and the returns will come. Better to learn early on when your portfolio is smaller so mistakes cost less!
This is why most fail and it’s better just to invest in index funds. So find someone who beats the market, demand to see their performance, and absorb and learn.
To your success,
Growthstocksroc
ps: If would like to share with a friend, please use this button:
David the Retail Investor vs Mr Goliath Market
David the Retail Investor vs Mr Goliath Market
David the Retail Investor vs Mr Goliath Market
It’s well known that over >95% of fund managers fail to beat the market over 15 years.
Why would a private investor be any better?
More stats can be found here:
(Source)
Doesn’t look good right? It looks like the probabilities are stacked against a private investor according to many analyses.
But look at the great investors; Peter Lynch, Warren Buffet, David Tepper, Terry Smith, to name a few, they were able to beat the market.
Were they just lucky?
Or in the right place at the right time?
Or was it skill?
That is the debate that rages over the dinner table in every part of the globe.
But, I have not seen any analysis or statistics on private investors vs fund managers. It simply cannot be done as it would be too complicated.
Certainly, we have data on stats on traders losing all their money, but stock investors are a far more secret world.
What about successful private stock investors, can you name a few of them? Probably many of these individuals keep their returns to themselves.
You can however find evidence on Twitter, of people beating the market. This is what got me involved in investing, as I saw >20% annualised returns from Saxena Puru and others.
In fact, my returns have beaten the market so far by following a few people on Fintwit, learning what makes a great company, and developing my own process of investment.
So let’s look at, what possibly gives the retail investor an edge and why many fund managers and hedge funds fail to beat the market:
1) Size advantages
First funds struggle to execute their strategy as they grow (fund elephantiasis): often a fund will start out with stellar performance, but as it grows it finds its opportunities reduce, because the size of the investment is much greater, for example, Berkshire Hathaway.
Early on Berkshire went from a small insurance company to a global conglomerate now worth >$500 billion, generating superior returns for investors. But over the last 10 years, it has failed to beat the SPY.
(Source)
Often us retail investors don’t have that problem because our funds are smaller and therefore our opportunity set of investments is greater. We can invest in smaller market cap companies more easily.
2) Diversification
Now, this is a grey area for the retail investor edge.
I’ll explain why.
Diversification is used to reduce risk in a portfolio. Higher diversification lowers risk, but also potentially lower returns (but not always, depends on the portfolio).
And the opposite can often be true, higher concentration, higher risk (but not always depends on the investments), and higher potential returns.
Now, what does risk mean?
Is higher risk, higher volatility?
Fund managers want to keep volatility and drawdown as low as possible to avoid investors freaking out and exiting out of the door.
This is one of the key retail investor’s edge.
Learn to stomach volatility and hold the fastest growing companies to generate better returns than the index.
As much as investment professionals would have you believe volatility does not equal risk. Permanent loss of capital is a risk.
Avoid losing your capital where ever possible.
Develop a due diligence process to select only high-quality companies, to reduce your chances of permanent loss of capital.
But look at some of the outperforming UK funds that have concentrated portfolios. The Scottish Mortgage Trust which has consistently beat the market has 85% of its funds invested in 37 companies and 48% in its top 10. Its bet on Tesla paid off and 2020 was a big year for outperformance.
Terry Smith’s equity fund which is beating the market also has a concentrated portfolio of 30 investments.
Maybe these funds point to portfolio concentration as a successful method?
As retail investors, we don’t have to answer to anyone, no quarterly performance reviews, or having to attract additional funds by pitching our performance and low drawdown. Although, possibly we have to justify a monthly investment budget with our wife or our family.
Therefore, we can run a concentrated portfolio of 10-30 holdings if we want. We can get a higher return for higher risk. There is no risk manager looking over our shoulder.
Of course, back your favorite ideas with a larger percentage of your portfolio if you have high conviction. That's your choice. That's your edge to play the market.
The counter to portfolio concentration is the higher risk of an investment not working out and causing a higher drag on returns. So bear this in mind. That is the skill.
Same reason we should avoid loss of capital as large drawdowns require larger returns to make those returns back.
Investment funds generally stick to one type of strategy, they are an emerging market fund, a small-cap fund, and have a specialism. Whilst a retail investor can hold many different types of stocks. You have the flexibility that a fund does not. Large-cap, small-cap, alternatives, etc.
Just focus on compounded gains and you will win.
Personally, I aim for a portfolio of 15-20 stocks and have higher amounts ~10-15% in my highest conviction ideas. But this of course is a personal choice and everyone is different in their preferences.
3) Long term thinking
Fund managers move firms, fund managers retire, fund managers die, fund managers need to produce short term results and they need to attract business so they need stable consistent returns.
Many of the reasons why funds underperform over the long term.
So we have a major advantage in that we can think long term and don’t have to get our yearly performance up or drawdown low.
Often times our investments will do nothing or even underperform and then accelerate to outperformance.
We will stay with our investments a long time and maybe even until we die, so that’s our edge.
All we need to do is pick growing companies and hold them for the long term to allow for compounded returns from reinvested profits.
That may be over 5, 10, or even 20 years.
So you must think long term as that’s where the best returns come.
Just look at Starbucks, MasterCard, and Home Depot amazing returns over 10 years.
In the words of Terry Smith:
That is how the money is made.
3) Performance fee edge
You get to earn every penny of performance you generate. 1-2% is usually paid out to a fund manager and hedge funds can take even more.
Over the long term, this can be worth thousands of $$$ and can hit your returns. So you get an instant performance boost when you take the DIY route.
The key retail investor disadvantages:
Number one from my point of view is confidence in your analysis and decision-making. Money is an emotional topic for most people and is the place of lots of misguided thinking. Therefore fear and greed can affect our behavior which hurts performance.
No risk manager, no colleague to discuss an investment decision with can often be a big disadvantage.
It’s not easy to get around emotional decision making, you need to protect yourself from doing something rash. Often having a framework for decision making can help, but often such decisions are a balance of probabilities so a rigid framework does not always work.
But live through pain and experience and you will come out stronger. There is only one way through fear and greed and that is straight through it. It’s taken 10 years to overcome my emotional decision making around money. I am not perfect but much better than I used to be. It can be done.
Things that can help are letting your winners run.
Keep your best investments, add more money to them and don’t sell too early.
Often the best stocks are always at their highs, which is challenging because you naturally want to trim or sell to take profits.
You think it can’t go any higher, but often because of the way compounding works the best businesses can go many thousands of percent. Just look at amazon an investment of $1000 in 2009 at a share price of $58 would have netted you 5662% (or 56 times your money: $56,000).
All along the way the stock was at its highs and people calling it overbought and overvalued. Yet there was nothing to stop this juggernaut.
Seems unreal, right? Yet people made fortunes from one stock.
Examples like Amazon don’t come around every day, but you should focus on the concept of holding winners and they will eclipse your failures and mistakes.
You only need a handful of large winners in your career.
You just have to hold for the long term
Every investor has an experience that haunts them and promises never to do it again.
I have two: Bitcoin and Tesla.
I bought 2 bitcoins at $1000 (now $37k) and got rid of my Tesla shares way too early.
This pain of missing out causes me to refine the process for selling which involves adding into winners and leaving losers well alone.
You never know when they will come back. I do sell if there is fraud or an underlying reason, but 80% of the time I just hold the investment.
My new motto is:
Time and information
Services like Motley fool or a select few on financial Twitter can help find opportunities and provide investment ideas, but you need to find your style and process. Take time to develop your skills and the returns will come. Better to learn early on when your portfolio is smaller so mistakes cost less!
This is why most fail and it’s better just to invest in index funds. So find someone who beats the market, demand to see their performance, and absorb and learn.
To your success,
Growthstocksroc
ps: If would like to share with a friend, please use this button:
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Nothing in this post is intended to serve as financial advice. Please do your own research.