Advantages to Being an Individual Investor
By
Paul Goodwin, Editor of
Cabot China & Emerging Markets Report
From Cabot Wealth Advisory 1/12/09
Sign up for free Cabot Wealth Advisory e-newsletterIf you've ever thought about how you—one lone individual out there making your investment decisions on your own—can possibly hope to beat the results of a large mutual fund, here's how.
Yes, it's true that a big investment company has enormous resources. Analysts can chop and count every number about the target company, figuring out the history of the company's revenues, earnings, cash flow, free cash flow, working capital, debt, overhead, liabilities, taxes, expenses, productivity, raw materials, etc. They can figure every valuation ratio in the book and even invent more. They can also visit every company whose stock is under consideration, getting face time with management and taking the temperature of employees. In other words, they have access to lots of information.
In the final analysis, however, big mutual funds have three disadvantages that give a small, individual investor a fighting chance.
First, most mutual funds operate under guidelines that require them to remain invested at all times. Investment guidelines are contractually binding and specify what money managers may and may not invest in. Most stock funds are required to have 95% or more of the fund's money invested in the prescribed asset classes at all times.
The advantage for you, the individual investor, is that you can jump out of the market and go to cash when stocks are diving like a rock. The manager of the small-cap value or large-cap growth fund, on the other hand, can only move toward the best stocks in that class. As your 401(k) results may have told you, this hasn't been a very good allocation during the last six months or so.
The subscribers to Cabot growth stock newsletters, by contrast, have been sitting in cash for much of the worst of the Big Bear Market of 2008. Much better than the alternative.
Second, mutual funds are big. When they buy, stocks go up and when they sell, they go down. This is a problem for a big fund that wants to dump a stock. But they have very skilled people who can unwind a position over a period of weeks without having the market notice.
Unfortunately, the stock market often doesn't wait weeks to knock a stock off its pedestal and grind it into the dust. So while you're pushing the button to sell a plunging equity, the big investor has to decide whether to join you in selling immediately (thus pushing the stock lower and probably scaring off potential buyers) or trying to parcel out sells in hopes of avoiding a price collapse.
The real disadvantage for the big investor here is that they must try to predict the future, steering their funds toward where they think markets will be months from now. As I've said here many times before, predicting the future is not something anyone has ever been able to do consistently over time.
So, your first two advantages are that you can go to cash and you're nimble.
Your third advantage is that you're really trying to make money, while the mutual fund manager is just trying to beat an index.This may not sound important, but it's actually a ginormous difference.
The mutual fund manager has an index that has been designated as the benchmark for the fund. So a large-cap growth fund manager is trying to earn a few basis points more than the S&P 500 Index, which will put the fund into the top quartile of funds in that asset class.
To beat a benchmark, the manager uses most of the fund's money to buy exactly the same stocks in the same weighting in the relevant index, right down to the 10th of a percent, stock for stock. Then the manager makes bets by under- or overweighting the fund's holdings of a few stocks versus the index. Some managers, especially those of small-cap funds, will
sometimes make out-of-benchmark calls by buying stocks that aren't even in the benchmark.
Ultimately, however, it's the benchmark that's setting the course, with the manager just trimming the sails a bit.
As an individual growth investor, your advantage is obvious. Not only are you not charging yourself a management fee, you're free to buy whatever you want, regardless of any index, sector, industry, country, capitalization or style.
So what are your advantages as an individual investor?
- You can go to cash when market conditions turn adverse.
- You can move in and out of issues quickly.
- You can manage your money to make money, not to beat a benchmark.
It's still not easy, but you have some powerful factors on your side and a powerful ally in Cabot growth letters—
Cabot Market Letter,
Cabot China & Emerging Markets Report,
Cabot Green Investor and
Cabot Top Ten Report—to help you make use of them.
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