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The small investor vs the market

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The Small Investor Vs. The Market

Following the major market forecasters is not a good idea, because many people do that, and that is exactly what makes it so hard to beat the market. Many "easy ways to make money in stocks" fail for two reasons: first, the natural tendency of trends to reverse over time, or "regression toward the mean", and secondly, if it does work, it won't anymore once too many people do the same thing.

If the stock price of a very successful company falls, it does not always reflect doubt about the future growth of the company, but rather lack of confidence in the valuation that the stock market itself had placed on the company's future.

Practice your judgement of whether a stock decline or a market decline is justified. That should be your basic advantage. The stock price or the market can reflect other people's mistakes of judgment. It helps to think of the market as a single person. What a single person would tell you is not always right. Especially if this person often lets his enthusiasm or fears take hold of him, as the market often does. You should buy when the market sells to you at a low price, and sell to the market when it buys from you at a high price.

Good, no-nonsense information for small investors: http://www.make-money-stock-value-investing.com

Do what the big guys cannot do

As a small investor, you compete with professionals. Professional investors have the following handicaps:

1. They must gravitate towards the biggest stocks, the ones they can buy in multimillion dollar quantities needed to fill their portfolio.

2. Investors tend to pour more money into mutual funds when the market rises, forcing managers to buy high.

3. Investors take their money out of mutual funds when stocks decline, forcing the manager to sell low.

4. Everyone measures their return against the S&P500 and other indices. When a company is added to the index, many managers buy it, because if they do not buy it and the stock increases (causing the index to increase), they will underperform the market. If it decreases, they still have a chance to beat the market.

5. Many funds have become specialized (small growth, mid-size ...), therefore they have to let go when a stock goes out of the prescribed range, even if it is a good stock.

Keep cost down
Save brokerage costs by trading rarely and cheaply. Get mutual funds with low fees. Diversify. Hold stocks at least one year to lower your capital gains tax.

In the short run, your returns are subject to market sentiment, which you cannot control. But here's what you can control:

- The amount you pay in brokerage fees
- Your own expectations (Updegrave, "Keep it real", Money, Feb. 2002,p53)
- How much risk you take
- Your own behavior

Self-control is important.

If you want to invest for about 25 years, buy monthly, automatically, and whenever you have money (dollar-cost averaging). For lifelong investment, get an index-fund. Sell only when you need cash.

When stocks go down, the media sound pessimistic, but there is just as much reason to be happy, since stocks can be bought more cheaply. Studies have shown that investors who got frequent stock price updates earned less than investors who got no news at all (see also Zweig, "Here's how to use the news and tune out the noise", Money, jul 1998, pp63).