The odds are stacked against you. But, if you follow these 3 simple strategies, you too can beat the City whizz-kids.
Institutional or individual investor, we're all here because we're playing a game -- and the game is called "find the 50-pence pound."
But you should know that this game is fixed -- and not in a good kind of way. Institutional players are going to steal the shirt off your back unless you take the time to understand how and why.
The Market Behind The Curtain
The market is a great thing, but it's not around to help you make money. In fact, the market primarily benefits two sets of financial institutions: the brokerage houses that are the conduits to the market itself, and the large-scale asset managers. And until very recently, you didn't even have the ability to get in on the market by yourself. Individuals could only participate with the assistance of expensive intermediaries.
Today, many of the barriers to individual investing have disappeared -- but not because financial institutions felt bad leaving you out of the action. No, no. The reality is that these crafty businesses realised they could make an absolute fortune bringing you into the game.
See, the vast majority of individual investors will not beat the market over the course of their investing career, thanks to the combination of three fundamental realities:
1. Institutions own the arcade, making them the effective gatekeepers of all trades. Every time you buy or sell, the institutions get to collect their toll.
2. Institutions control the money. With around 70% of the market's assets in the hands of investment firms, they have the ability to move (or create) markets whenever they wish.
3. Institutions are very well-armed. They have more intellectual, financial, and computational firepower than you could ever dream of. Whatever information or insight you're able to generate on your own is likely to be old news to them.
These market truisms help set the stage for widespread individual investor underperformance. But the fact is, institutions don't care whether you win or lose. They just want you playing the game as often as possible.
So what do you do if you want to actually win?
Rule No. 1: Don't Play Their Game
The messages we get from most financial institutions are all pretty much the same. Most involve a smattering of strategies that include constant trading, significant portfolio turnover, and an eye that is fixed on the daily news cycle. Never mind that study after study proves these principles are useless, and will cost you about 5% annually in charges for as long as you keep them up.
So why do those financial experts keep promoting them? Simple. Financial institutions and their brethren profit from them. They earn commission or advertising revenue, and they get the added benefit of competing against individuals who will operate in a very predictable fashion. Both work heavily to their advantage.
To level the playing field, then, consider doing the following:
1. Don't attempt to time the market.
2. Don't trade frequently without a very good reason.
3. Don't buy into the "insight" of the financial media.
Bottom line: The stocks you buy are not lottery tickets meant to be scratched and then thrown away. They represent fractional ownership of a real, live business. So focus on fundamental analysis gleaned directly from audited financial statements, buy shares that are selling for less than their intrinsic value, and plan to hold your investment until your thesis has manifested.
But if you're smart, you want more than just a level playing field.
Rule No. 2: Know Thine Enemy
Ask any fighter: The single best way to defeat an opponent is to identify his weaknesses, and then exploit the hell out of them.
Institutional asset managers have two massive weaknesses that you should punish at every opportunity:
1. Most institutional investors are obligated to focus on the short term.
2. All institutional investors are handicapped by their own size.
Institutions live and die by their performance. Good performance attracts new capital, which leads to more money in their pocket. And, as you might guess, poor performance does much the opposite. This reality means that most institutional investors can't afford to suffer even the briefest periods of poor performance.
These short-term pressures force many institutions to simply avoid buying shares like BP (LSE: BP), Reckitt Benckiser Group (LSE: RB), and Shire (LSE: SHP), even if they know they're excellent long-term holdings (which they are).
Here's how you can flip this weakness around on them: Ride out the inevitable volatility of the stock market by buying and holding great companies for the long term. This also avoids the costs of unnecessary trading, which bring down your overall returns as well.
The larger and perhaps more crippling weakness of institutional investors is their sheer size. When you're investing billions of pounds, it's just not worth your time to go after small-companies such as Immunodiagnostic Systems (LSE: IDH), ITE Group (LSE: ITE), and Spice (LSE: SPI). The big guys would if they could, but their own wealth holds them back.
Again, here's where you can capitalise. Take advantage of the exponential growth that happens early in the development of superstar companies, especially when the big boys can't or won't. Remember, a £100 million company can reward you just as well as a £5 billion one.
Rule No. 3: Change The Rules
In other words, if you want to beat the market -- and the City -- you need to do two things:
1. Bypass the short-term irrationality of the market by purchasing shares the City has discounted for near-term issues and then hold them for the long term.
2. Focus especially on those companies that are generally too small for institutions to play with, because you'll generate superior returns in this category.
You'd be astonished how quickly the City will turn its back on fantastic businesses like IG Group (LSE: IGG) when the waters get even a little bit choppy -- because they have to. So go on, play the game with the big boys. But play it in ways they don't want you to.
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> A version of this article was originally published on Fool.com. It has been updated by Bruce Jackson, who does not have an interest in any of the companies mentioned in this article.
