Professional fund managers have many advantages over private investors. For a start, it's highly likely a fund manager will have much more time for investment research than the average private investor. They also have access to powerful investment databases such as Bloomberg that assist in the decision-making process. Furthermore, city professionals often have the opportunity to speak directly with the management of companies in order to get a thorough understanding of the company's prospects.
However while it may seem investing is rigged in favour of the big money, there are many key advantages that the small investor has. Let's look at several of these.
It's no secret that shares are a long-term investment. The real power of the stock market comes not from what the market does over one year or three years, but from compounding the returns over a much longer period.
Ironically, fund managers often take quite a short-term view, simply because they're judged on their short-term performance. Fund managers are usually required to provide yearly, quarterly and monthly performance figures and investors can be impatient. If the fund significantly underperforms the benchmark, the professional may be at risk of losing their job.
This is where private investors have an advantage. In reality it's no big deal if your portfolio's performance is a little underwhelming in the short term. Focus on building a formidable portfolio over the long term and allow the power of compounding to work its magic.
Another key advantage of the private investor is a lack of portfolio constraints. Investment funds often have a set of rather inflexible rules, such as stating that the fund can hold a maximum of 10% cash, or that the fund manager can only invest in FTSE 100 stocks.
By contrast, the private investor has significantly more flexibility. Want to hold 30% of your portfolio in cash because you think the market is overvalued? No problem. Want to buy US listed shares? Easy. Not seeing any value in the market? As a private investor you can simply wait on the sidelines until an opportunity presents itself and then look to take advantage.
Professional investors also often like to follow the herd. The belief is that it's better to be incorrect with the herd and maintain job security than stick your neck out and come under scrutiny if your calls are drastically wrong.
However, the private investor is free to take a contrarian approach. For example, defensive stocks have fallen out of favour in recent months, yet over the long term, they've proven to be strong performers. The private investor has the flexibility to buy now, free of judgement, and this is an advantage.
Lastly, small-caps are a potentially highly profitable area of the market that private investors can take advantage of at the expense of larger, institutional investors. Fund managers often have huge amounts of capital to invest and as a result, this rules out many smaller companies as potential investments, as a large position in a smaller company would most likely cross ownership thresholds.
As a result, it leaves many smaller companies under-researched and mis-priced. For private investors willing to research the smaller end of the market, significant opportunities exist.
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