Five ways small investors can gain a big edge over the professionals

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We were talking to an investor the other day, and he indicated he didn’t like the stock market because ‘the big players have all the advantages.’ He had heard about high-frequency trading, insider dealer, brokers manipulating prices and financings, and other nefarious goings-on.

This dismayed us. Sure, the market is not perfect, and scams occur. But for building wealth, we still think it is the best game in town. We just like the math: Even if you do get caught holding a scam company and lose 100 per cent, if you get a winner you will offset that loss many times over. This year has more than proven that. A quick Bloomberg screen tells us there are 116 stocks in North America up more than 100 per cent already in 2020.

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Five ways small investors can gain a big edge over the professionals Back to video

So, to help our friend see the light, we are offering five reasons why you — the small investor — actually has an advantage over the “big boys.” As a former fund manager, we can assure you all of these are of significant advantage to the individual investor: we have been on both sides of the table here.

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You have no ‘money flow’ issues

As a fund manager, one of the biggest challenges is how you handle the flow of money into and out of the fund. Of course, when markets are strong, more money comes in and needs to be spent. But the bigger problem is when money leaves your fund. Of course, this always happens when the market is down. Fund redemptions must be met. If you get a large withdrawal — guess what — you are now selling in a panicked market. This is never good for performance, and I still have nightmares about trying to meet redemptions in the 2008 market decline. No one was buying, but a lot of investors still wanted their money out of the market. You, as an individual, never have this problem. You are, for the most part, fully in control of when you invest and when you take money out. Sure, you might need money for a purchase, but again, you are in control of the process. Fund managers have absolutely no control over money flows.

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You have lower commissions

Trading commissions keep moving lower, and have gone to zero in the U.S. Institutional funds still pay pretty high commissions, however, often one cent per share or more. When you are trading millions of shares, these can still add up! Most individual investors would switch brokers if they had the gall to charge them one cent a share to trade.

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You (nowadays) get the exact same information as the big players

The more experience I got as a fund manager, the fewer meetings I found myself attending. How come? Well, following new disclosure rules, company executives simply became more tight-lipped. They were absolutely paranoid about disclosure, as they could not tell one investor anything that was not widely disclosed as well. The upshot: Investor meetings became far less useful as time went on. Nowadays, you as an individual have pretty much the same information as all the big players. Sure, fund managers can look executives in the eye and get a “feel” for a company. But trust us, many executives are polished salespeople and can spin a story like you wouldn’t believe. We learned early in our career to let the numbers do more of the talking. Individual investors thus get the exact same financial information as the big boys.

You have no market impact when buying/selling

When a fund manager puts in an order to buy, say, a million shares of stock XYZ, he/she knows it may be difficult to get at the current price. Large buying, naturally, tends to move a stock up. Suppose a stock is $10/share. As a manager, you still need to like that stock at $10.50, or even $11, because that’s what you will likely need to pay to get the position you want. This price move, of course, limits your investment returns. But individual investors just don’t need to deal with this. You want a thousand shares, you buy it. If you don’t get it at $10.00, maybe you get at $10.01. That price difference and lack of market impact on your trades can give you a significant return advantage over the big players in the market.

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You have no boss

As a fund manager, everyone has a boss. Even if you are the CEO, the ‘bosses’ are your clients. When your boss questions one of your stock selections, you start second-guessing yourself. If you are wrong, you are now an idiot and should have listened to your smart boss. It might cause you to make stock moves that you might not want to. As a junior manager, I have had bosses who have sold stock against my wishes. But the worst boss is having an investment committee. As anyone knows, committees are pretty useless. Say you have the best investment idea around. But you need to get all trades approved by your investment committee. If one person at the table doesn’t like your idea, you might not be able to buy that investment you love. This is absolutely beyond frustrating, yet is common in the industry, particularly with pension funds. Even if you are allowed to buy, just setting up the stupid investment committee meeting might lose you valuable time before buying. But you — as an individual investor — have no boss. You want to do something? You do it. No approval, no committee, nothing is needed.

Peter Hodson, CFA, is Founder and Head of Research at 5i Research Inc., an independent investment research network helping do-it-yourself investors reach their investment goals.