I was talking with a friend who runs a successful hedge fund on the West Coast. He has made a lot of people a lot of money over the years but is lagging the all-powerful indices so far this year.
Despite his excellent performance over the past decade, he is already starting to hear from the "what have you done for me lately crowd." "It would be so much easier," he said, "to just run my own money without people looking over my shoulder all the time." This led us to a conversation about the powerful advantages individual investors have, and how they all too often fail to use them.
When I started in this game back in the 1980s, all the advantages were in favor of the institutions and professionals. If there was breaking corporate news back then you didn't get it instantly in your in box. You got a call from your broker (maybe) hours after the news broke and the stock or market had already moved. There were no CNBC or Fox Business News channels offering instant updates. Unless you had a ton of spare change lying around to install a Quotron in your home and office, you were at a tremendous news disadvantage. If you wanted to know where a stock was trading you called your broker to find out instead of refreshing your screen.
Costs were a lot higher then, too. The minimum spread was $1.25 a share and even after the big bang that ended fixed commissions, the costs of trading were something on the order of tenfold higher for individual than for the large funds. And traders were paying to trade stocks, options and commodities. Today, we have penny spreads and you can trade thousands of shares of stock for less than $10 total in most cases.
The disadvantages have faded into history and individuals still have powerful advantages if they choose to use them. First, as my friend pointed out, there is no one looking over your shoulder all the time. If you lag the market for a bit but have a high degree of confidence in your portfolio on a longer-term basis, you don't have to defend your positions 10 times a day. There is no institutional mandate that forces you to be 80% invested at all times or a limit on which securities you can own. No one is going to read your regular shareholder letter and ask why you own dogs such as Cliffs Natural Resources (CLF) and not superstars such as Tesla (TSLA). No one will question your sanity for holding cash in a lower rate world. You can set your own guidelines and goals and act accordingly.
Second, individuals have a huge size advantage. They can own small stocks that the large institutions simply cannot. In my "trade of the decade" portfolio. I have had five banks taken over in the past five years with average gains of more than 50% on those stocks. The original market cap of these banks was on average less than $50 million and the smallest was $9 million.
It is not just little banks either. There are some tremendous companies trading at bargain prices whose market caps are too small for the big institutions to bother even considering. It is huge advantage but virtually no one uses it -- they mistake liquidity for risk and limit their profit opportunities.
Third, an individual has the advantage of time. You do not have to play the quarterly performance game and buy or sell stocks to juice your short-term returns. You have the luxury of holding onto a position until you are able to obtain full value for your securities -- no matter how long it takes. You won't have to sell stocks to meet redemption requests and no one is going to fire you for holding stocks for long periods of time.
The playing field has leveled out over the decades. Individuals have access to instant real-time quotes and news at the touch of a button. Costs have plummeted and, while the big boys may still pay less, we don't pay very much to get our trades executed.
We also have the huge advantages of time, flexibility and size in our favor. More individual investors should take advantage of the opportunities that tilt the playing field in their favor.
At the time of publication, Melvin was long CLF.