I frequently make the case that individual investors have little hope of reliably outperforming the market by trying to pick investments on their own. A recent comment on a post from a couple months ago argued that individual investors do have some advantages that might help them reliably outperform the market.
The commenter pointed out that:
- Mutual funds are required to stay within a given asset allocation range. Individual investors, on the other hand, can move entirely to cash or entirely to stocks whenever they see it as beneficial.
- While each individual trade is a zero sum game in terms of who will come out ahead, some investors aren’t necessarily seeking to come out ahead. That is, “Zero sum games can be beat if everyone is playing for different reasons.” For example, elderly investors might buy dividend stocks simply because that’s what they’re comfortable owning.
Individual Investors vs. Mutual Funds
Regarding the first point, that’s true. Fund managers are not allowed to move entirely into cash whenever they see fit. (Thank goodness!) People have been bringing this up for years. (They usually also point out that fund managers can’t invest more than 5% of the fund’s assets in a given stock, whereas individual investors have the ability to do so.)
Admittedly, these are at least potential advantages to individual investors. The problem is that to be able to exploit these advantages, investors have to be able to:
- Predict short-term market movements (such that moving into or out of cash would be beneficial), and/or
- Pick stocks that are likely to outperform the market (such that putting a large portion of one’s portfolio into a given stock would be beneficial).
Every piece of data I’ve seen on the topic indicates that individual investors have little hope of being able to perform either of these feats reliably. And that makes sense; most of us just don’t have the resources.
Individual Investors vs….Other Individual Investors
As to the second point above–the one about zero sum games–again, this one makes sense on a (wonderfully fascinating) theoretical level, but it seems difficult to exploit to one’s advantage.
Even if we assume that there are investors who buy stocks without the intention/hope of beating the market, what percentage of stocks do these investors own? I suspect it’s rather small.
And, more to the point, I’d be willing to bet that these older investors have far lower portfolio turnover than most other market players, meaning that the likelihood of one of these investors being on the other side of any given trade is exceptionally low.
Am I missing something?
What do you think? Is there something I’m leaving out that gives individual investors a meaningful advantage over other market players?