| Free Article |
Why the Individual Investor Often
Has an Advantage Over the "Pros"
by Dave Van Knapp, author of
SENSIBLE STOCK INVESTING:
How to Pick, Value, and Manage Stocks
and
THE TOP 40 DIVIDEND STOCKS FOR 2010:
How to Generate Wealth or Income from Dividend Stocks
March, 2007
Famed investor Peter Lynch said, “...the amateur investor has numerous built-in
advantages that, if exploited, should result in his or her outperforming the
experts, and also the market in general.”
Many people believe that an individual cannot beat the market. They think that
they cannot, over long periods of time, generate better returns than the market
itself, nor outperform professional money managers who, after all, do this for a
living.
But Lynch was right. Many individuals can and do beat the market and the
experts. Let’s see why the individual investor actually has certain advantages
over the pros.
First, as an individual investor, you run your own shop. Unlike many
professional money managers, no boss is telling you to be fully invested. If,
during bad market conditions, cash is the best place for your “stock money,”
you can keep it in cash and no one will fire you. You can wait for the right price
or for other conditions you may require. You can even get out of the market
entirely for awhile. You decide what to do with your capital. You are your own
fiduciary.
Second, the amount of money you have to invest is small compared to, say,
mutual funds. Many mutual funds own unattractive stocks. They do so
because they have so much money to invest. So the fund managers go through
their first tier of good ideas and on to their second tier, and maybe even into
their third. Their fund’s charter may require diversification across a broad range
of stocks or investment in illogical sectors. You, on the other hand, can keep
your holdings concentrated in your best opportunities.
Third, you can control expenses better. You can buy and sell using the cheapest
brokerage—the execution of stock trades, after all, is a commodity service.
Why pay $20 or $100 per trade when you can get it done for $10 or $7 or even
less? Plus, as your own boss, you don’t have to pay management fees, “wrap”
fees, or marketing expenses, none of which help returns. All of the information
you need to invest intelligently is readily available, and it is free, often pre-
processed for you. So you don’t have to pay for analysis…you do it yourself.
Fourth, you will (of course) keep your own best interests in mind. Sad to say, at
many mutual funds, the primary mission is to attract more investors and grow
the fund. Incentives are set that way. Oddly, analysts and brokers are often not
incented to actually produce good returns for you. Your personal incentive, in
contrast, is to take care of your money. Nobody will ever manage your money
better than you will. Nobody cares more, and nobody understands you better.
Fifth, you control taxable events. Until a stock is sold, no taxable event takes
place. Capital gains (or losses) are just on paper. Mutual fund shareholders own
shares in the fund but not in the individual stocks that the fund owns. Therefore
they are at the mercy of sell decisions made by the fund’s managers. A mutual
fund can generate taxable gains even though the fund itself declines in value.
This happens all the time, when the fund sells some stocks at a profit but does
not offset those gains by selling other stocks with losses. So the fund has net
profits on its trades even if the total asset value of the fund is lower overall. The
net trading profits (by law) are passed through to the fund’s owners. Those
unfortunate souls are left not only with a tax bill but also with an investment
worth less than before. By contrast, if you own individual stocks, you are in
sole control of selling decisions and the attendant tax consequences.
Finally, you don’t have to worry about “style drift.” For example, the rules for a
small-company mutual fund may force the fund’s manager to sell a stock if its
market size exceeds a certain limit. That’s what its prospectus promises its
investors. But that growth is just what you are looking for! You want your small
companies to succeed and become large companies. You don’t want to sell
those stocks, you want to keep them as long as they are performing well.
Peter Lynch had it right. He understood that the individual stock owner holds
some cards that the professionals only wish they had. If the cards are played
right, the individual can surpass both the pros and the market.
Has an Advantage Over the "Pros"
by Dave Van Knapp, author of
SENSIBLE STOCK INVESTING:
How to Pick, Value, and Manage Stocks
and
THE TOP 40 DIVIDEND STOCKS FOR 2010:
How to Generate Wealth or Income from Dividend Stocks
March, 2007
Famed investor Peter Lynch said, “...the amateur investor has numerous built-in
advantages that, if exploited, should result in his or her outperforming the
experts, and also the market in general.”
Many people believe that an individual cannot beat the market. They think that
they cannot, over long periods of time, generate better returns than the market
itself, nor outperform professional money managers who, after all, do this for a
living.
But Lynch was right. Many individuals can and do beat the market and the
experts. Let’s see why the individual investor actually has certain advantages
over the pros.
First, as an individual investor, you run your own shop. Unlike many
professional money managers, no boss is telling you to be fully invested. If,
during bad market conditions, cash is the best place for your “stock money,”
you can keep it in cash and no one will fire you. You can wait for the right price
or for other conditions you may require. You can even get out of the market
entirely for awhile. You decide what to do with your capital. You are your own
fiduciary.
Second, the amount of money you have to invest is small compared to, say,
mutual funds. Many mutual funds own unattractive stocks. They do so
because they have so much money to invest. So the fund managers go through
their first tier of good ideas and on to their second tier, and maybe even into
their third. Their fund’s charter may require diversification across a broad range
of stocks or investment in illogical sectors. You, on the other hand, can keep
your holdings concentrated in your best opportunities.
Third, you can control expenses better. You can buy and sell using the cheapest
brokerage—the execution of stock trades, after all, is a commodity service.
Why pay $20 or $100 per trade when you can get it done for $10 or $7 or even
less? Plus, as your own boss, you don’t have to pay management fees, “wrap”
fees, or marketing expenses, none of which help returns. All of the information
you need to invest intelligently is readily available, and it is free, often pre-
processed for you. So you don’t have to pay for analysis…you do it yourself.
Fourth, you will (of course) keep your own best interests in mind. Sad to say, at
many mutual funds, the primary mission is to attract more investors and grow
the fund. Incentives are set that way. Oddly, analysts and brokers are often not
incented to actually produce good returns for you. Your personal incentive, in
contrast, is to take care of your money. Nobody will ever manage your money
better than you will. Nobody cares more, and nobody understands you better.
Fifth, you control taxable events. Until a stock is sold, no taxable event takes
place. Capital gains (or losses) are just on paper. Mutual fund shareholders own
shares in the fund but not in the individual stocks that the fund owns. Therefore
they are at the mercy of sell decisions made by the fund’s managers. A mutual
fund can generate taxable gains even though the fund itself declines in value.
This happens all the time, when the fund sells some stocks at a profit but does
not offset those gains by selling other stocks with losses. So the fund has net
profits on its trades even if the total asset value of the fund is lower overall. The
net trading profits (by law) are passed through to the fund’s owners. Those
unfortunate souls are left not only with a tax bill but also with an investment
worth less than before. By contrast, if you own individual stocks, you are in
sole control of selling decisions and the attendant tax consequences.
Finally, you don’t have to worry about “style drift.” For example, the rules for a
small-company mutual fund may force the fund’s manager to sell a stock if its
market size exceeds a certain limit. That’s what its prospectus promises its
investors. But that growth is just what you are looking for! You want your small
companies to succeed and become large companies. You don’t want to sell
those stocks, you want to keep them as long as they are performing well.
Peter Lynch had it right. He understood that the individual stock owner holds
some cards that the professionals only wish they had. If the cards are played
right, the individual can surpass both the pros and the market.
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