In the first part of this series, I noted five disadvantages average investors have in today's market. But before you stuff all your money under your mattress, you should know you have advantages of your own. It may surprise you, but there are some places where the big money lags behind.
1. Allocation flexibility
Many funds are managed with a stated goal in mind. It may be called "small cap," "aggressive growth," or "dividend-only." In many cases, this restricts what the portfolio can be invested in. Even if the manager of the dividend-only fund sees a non-dividend stock trading at an excellent valuation, he or she couldn't buy it because it would violate the structure of the fund. Many institutions also restrict purchases of stocks trading under $5 per share or under a certain market cap, keeping these traders from purchasing what are sometimes excellent values or growth prospects.
Even in cases where the company has noted its intention to pay a dividend in the future, dividend-only funds are usually restricted from buying. After noting the probability of a dividend months before each announcement, shares of Delta Air Lines (NYSE:DAL) and American International Group (NYSE:AIG) both posted strong gains on the days when the dividends were officially declared.
If you spend the time to search out the best investments, you have the flexibility to invest in pretty much anything you want. A blue-chip bond to go in your otherwise speculative growth portfolio? Why not? An emerging tech company to mix in with your dividend picks? Go ahead.
2. Control of cash flows
Many people question why fund managers sell so much stock at the bottom of the market only to be buying back in as it rises. But, to their credit, the decision is often beyond their control. Clients have their money in a fund, and when a recession hits, they need it back. When lots of clients need their money back, the fund needs to sell at the bottom -- a.k.a. the worst possible time.
While some average investors are unfortunately forced to also sell at the bottom to make ends meet after the loss of a job, those who remain on solid financial footing can choose to ride out the storm or even put more money in. And there certainly is potential here. Had you put your money into an index fund based on the S&P 500 during the bottom of the market, you would have more than doubled your investment in only a few years
3. Small money
If you remember, I noted in the last part of this series that Warren Buffett's name and billions of dollars get him better deals than the rest of us. But Buffett doesn't count out the small investor. In fact, he has some interesting thoughts about investing an amount smaller than he has now. As noted in Business Insider, Buffett says:
If I was running $1 million today, or $10 million for that matter, I'd be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I've ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It's a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.
While Buffett does put it best, I will attempt to paraphrase. Basically, Buffett argues that with a smaller amount of money, investors can achieve much higher percentage returns more easily.
And this makes sense, too. After all, a lot of small-growth companies would be completely missed by Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B), since even their wildest success would only make a dent in Berkshire's bottom line. So for anyone with a sub-billion-dollar portfolio, you at least have a structural advantage over Buffett.
4. In the trenches
Financial analysts tend to see things from a financial perspective and miss many big growth stories as a result. Although market analysis may not be your trade, if you're involved in something like technology, design, or engineering, you could see the next big growth story before the financial types do.
Remember when Tesla Motors (NASDAQ: TSLA) was the unprofitable niche company that made an electrified Lotus and was going to be bankrupt in a year? Today, close followers of Tesla who bought in at the IPO have seen their money multiply over eightfold. So just because you don't spend your day glued to the markets doesn't mean you can't find the next investment growth stories.
5. Fees and commissions
If you read the first part of this series, you probably remember I listed this as a disadvantage to average investors. But while fees and commissions do eat up a larger percentage of each trade, many investors who have larger amounts of money turn it over to an actively managed fund.
At first it seems like the smart thing to do. After all, how could someone getting paid so much to manage your money actually be worse than an index at it? Turns out, in most cases and when fees are taken into consideration, they are. So if you want a leg up on your rich uncle's investment in an actively managed equity fund, go grab a piece of an S&P 500 index fund.
The average investor can win
The stock market is not where average investors should expect to get rich quick but, through a combination of advantages and disadvantages, an average investor who follows the basic rules of investing so be able to generate meaningful returns. Part of investing is knowing where your advantages and disadvantages lie and average investors have plenty of both.
Alexander MacLennan owns shares of Delta Air Lines and Tesla Motors. He also has options on Delta Air Lines and is long AIG warrants. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security.
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