Life's not fair, and neither are the markets. But to better understand where and when to invest, it's best to know where your advantages and disadvantages are as an average investor. In this article I will cover five disadvantages average investors face -- and in my next article I'll show you where the average investor has the edge.
1. Light-speed trading
When it comes to trading, it really doesn't matter how fast your reflexes are. Unless you can see the future, a computer many times more expensive than your own can beat you to it.
The biggest trading firms and financial companies have massive infrastructure ready to execute trades at a moment's notice, so don't try to build your trading strategy around clicking your mouse before everyone else.
2. Advance notice
If you think all information becomes available to everyone at the same time, you're wrong. For a fee, some traders can gain access to a market-moving number before nonpaying investors. One set of consumer confidence numbers is made available to those willing to pay a full five minutes before the information is made public.
But not even all the paying traders get the full advantage. An even more elite group gets the numbers two seconds before the rest. And with all those computer trading systems, a lot can be done in two seconds. Bottom line: Brace yourself for a market move either way, because you won't have first dibs on the numbers.
3. Name recognition and bulk buying power
A lot of people cite Warren Buffett's 2011 investment in Bank of America (NYSE:BAC) as a reason to buy the stock. While I still like B of A for the long run, you should consider the fact that Buffett got a much better deal than any average investor could. For $5 billion, Buffett's Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) got $5 billion in preferred stock yielding 6% and warrants for 700 million common Bank of America shares with an expiration date 10 years out. And if B of A wants to buy back the preferred stock, it will have to pay a 5% premium.
Buffett brought both his name and his money to the table. Not only did Buffett offer more money than any average investor could, but the confidence given by his name is a valuable asset when a CEO is trying to restore confidence in a bank following a financial crisis. So try to invest like Buffett, but remember: He can get better deals.
4. International access
Hedge fund managers and large financial companies can trade almost anywhere they want in the world at the drop of a hat. But finding the best opportunities internationally is more difficult for average investors. Consider that in 2013, Venezuela, Zambia, Nigeria, and Pakistan had four of the 10 best-performing stock exchanges.
Average investors can mitigate this lack of international options to some extent. Some brokerage firms offer accounts for international investing. But even with the help of these brokers, frontier markets will be out of reach for many average investors. For those still interested in frontier markets, an ETF can provide some exposure. Currently, the iShares MSCI Frontier 100 ETF (NYSEMKT:FM) offers a way to invest in markets otherwise difficult to buy into.
5. Fees and commissions
These destroy the returns of many average investors because every dollar spent on fees and commissions is one you cannot invest. For large trades performed by major investors, fees here or there are usually a drop in the bucket compared to the total investment, but for average investors, a commission can be a much larger part of a total investment.
Although fees and commissions aren't completely avoidable, average investors can lessen their impact by making fewer trades, making a large enough investment that fees and commissions don't eat up a large percentage, and searching for a broker with lower trading costs.
It's still worth investing
Looking at the huge profits made by hedge funds and their managers, many average investors feel the odds are stacked against them. But by knowing where to look for good investment ideas and keeping realistic expectations, you can mitigate many of these disadvantages.
And if you're reading this figuring the big money has all the advantages, then you should brighten your day by reading about the five advantages you have in the market.
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Alexander MacLennan is long January 2015 $20 calls on Bank of America and long Bank of America Class B 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. The Motley Fool recommends Bank of America and Berkshire Hathaway. The Motley Fool owns shares of Bank of America and Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.