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Oct 24

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Can you beat the index?

We’ve often been told that 75% of professional money managers fail to consistantly beat the index, so what chance does “the little guys” like you and me have of making money in the market. While there are advantages that money managers have, there are several reasons why I think an individual can do better than actively managed funds. So, here’s 10 advantages I think the individual investor has over the big money managers.

1) Scale

If I invest, my investment doesn’t have much of an impact on the market price, I’m too small. Investing a couple thousand in a stock is nothing (it probably won’t affect the stock price) compared to trying to buy a couple million. A move like the latter will impact the price. In some cases, it may not even be possible as you’d be buying an entire company…this of course leads to:

2) What you can buy

You can’t usually invest in small companies if you are a fund manager. Granted, most of these small companies are more of a gamble than an investment, but fund managers, because of their size, are usually locked out of this market completely. The reverse, I suppose, is also true…the average guy usually can’t purchase much Berkshire Hathaway.

3) The “need” to do something

Most actively managed funds trade a lot. They need to be seen as actively managing your money. They try to time the market to get optimal performance, or whatever. This trading triggers many fees (trading fees, taxes, etc.) which could affect their performance. For example, in the early days of Apple’s second coming, the stock went up in a rapid fashion. Let’s say the manager sold it off in one of the small pauses to realize the gain (let’s say after a 100% return). This would have triggered a capital gain withholding so, there is less money to reinvest than had he just left it sitting in Apple (which continued on to even more massive gains). Now, no one probably expected apple to grow like it did, nor could they be expected to predict the future, but holding Apple over those years was probably better than trading it.

4) Research and understanding

Personally, I’ve learned to only buy companies I use and understand. It’s been very good to me. I don’t just judge the company by the paperwork and news reports out there, I actually know the company and its products. I very much doubt most Wall Street managers have a clue about some companies they invest in other than as a stock ticker symbol. Nearly every perspectus I’ve ever read contains several companies I’ve never heard of before, and can find very little information on.

5) Restrictions

Actively managed funds are required to issue a perspectus which outlines what kind of companies or style of investing they will invest in and are limited to. Unless you monitor the market, you are stuck with that kind of investment no matter what happens.

Growth funds tend not to do well in a bear economy, but if you don’t change your holdings, there’s nothing the fund manager can do usually to change…it’s not like they could switch the fund’s holdings over to gold, for example, if there was a gold bull.

Just because you’re funds are actively managed, doesn’t mean you can ignore the market and what it’s doing.

6) It’s my money

No one cares more about my well being than me. The actively managed fund manager gets paid off the top no matter his performance. He loses half your money in a year, he still gets paid (he may not stay fund manager at this firm, but would probably find another job) meanwhile, you still only have half your money. It’s a lot harder to double your money to recover than it is to lose half. Also, the rewards for doubling your money aren’t as great as actually doubling your money (so the fund manager is faced with limited incentives to perform past a certain point).

The ROI I can get motivates me to do the work required.

7) Following the heard

There is no way to beat the market if everyone does the same thing. If everyone buys just thin index then the index will rise. It’s impossible to beat the index, because no one is buying anything else. Instead of focussing on the index (an imaginary standard to begin with), people should focus on actual ROI. If the index goes up 20%/year why complain? If it goes up 2% (or worse loses money) why are you happy?

When I buy investments, I’m looking for a high return period, preferably with some security like a dividend. If the stock gets beat up by market manipulation short term, I don’t really care if the ROI from my dividend is 10% based on my purchase price.

8) I can ignore the trend

Buy low, sell high an easy maxim that nearly no one can follow, especially fund managers. The market tanks, people pull their funds from you. You are in the best position to make money, but have nothing to buy with and are forced to lock in your losses to cover the cash call.

Of course, in a bull, everyone is pouring money at you when prices are at their peak and there’s nothing worth buying. As a manager, you need to do something with the funds, but are stuck because you know there’s no value out there.

9) People are told they can’t do it

When I first started in business, I was told I needed a lawyer to do a lot of things. For some things, this was true but for many things (mostly routine) I found that many lawyers had systems in place that “got the job done”, as opposed to getting the best result. I started looking into what was involved in many different things which “required” a professional and discovered that, in many cases, it wasn’t hard, there wasn’t any “special knowledge” required, and much of it was, in fact easy and cheaper to do myself. In fact, I’ve often gotten better results than had I hired a lawyer to go through his “routine” once I understood what was required.

Many people have said “75% of professionals can’t consistently beat the index”, so how many people even try it on their own? Heck, most of the people I know are afraid of investing in anything period.

I’ve been buying real estate for years with 100% financing (which many people say isn’t possible), I find houses below market in a boom period (which many people say is impossible), I’ve even written a book telling people how to duplicate it. So far, no one has come back to me saying my system doesn’t work, but very few people have bothered to initiate it themselves. Of course, I’ve had a lot of people ask if I would do all the work for them and let them have the houses and profits…

I’ve been buying stocks for years as well. I’m a buy and hold, value investor and I’ve done well. Both buy and hold and value investing fell out of favour years ago as a popular and trendy investing strategy…common knowledge says it doesn’t work.

I suppose, common knowledge could explain why my results in investing are uncommon. I don’t follow the heard.

10) People don’t even try

As I said, Ive sold a lot of books, and talked to a lot of people about investing and business. After talking, most people seem to realize that most of this stuff isn’t rocket science, and isn’t all that tough…but I know, upon leaving that, despite not being happy with their situation in life, they aren’t going to go that next step and actually “DO” something.

Most people give in to laziness, apathy, fear, or whatever and just return to the “same old, same old” that they are comfortable with. Change and uncertainty aren’t easy for most people to deal with, and few people realize that they their lifestyle is probably more insecure than mine is, despite the fact that I’m travelling on the uncommon path. I can’t force people to follow, all I can do is try and provide a road map. The decision to start the journey rests with you.

Lesson: If you follow “common knowledge”, and expecting uncommon results, why are you surprised? As Apple used to say…”Think Different”.

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