Stock Investing: Why the Individual Often Has an Advantage Over the "Pros"

By: David Van Knapp
Submitted: 2007-01-17 16:17:39
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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 $100 or $20 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. 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. Your 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 with a tax bill even if their investment is 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.

Article source: Expert Articles