In this age of high-speed algorithmic traders and big data, it’s easy to think that individual investors stand no chance against large institutions. Should we just throw in the towel? Not necessarily. Here are two reasons why I believe that individuals can still develop an edge in today’s markets.
It’s not about how smart you are
One of the most common reasons why people think the little guy can’t win is that they believe the banks and hedge funds possess information that they don’t have, or have more brainpower, more data, or are just plain smarter. Luckily, intelligence does not matter nearly as much as people think. Warren Buffett, one of the greatest value investors of all time, has frequently stated that investors only need to be of slightly-above-average intelligence to succeed.
Information is actually much more widely available today than it was in the past. Rules surrounding public disclosure are a lot more stringent today than they were in the past, which means that regular investors have access to almost all the same information that the big institutions do. So in that sense the proliferation of information has levelled the playing field. Now, you can’t be an expert on everything. But you can be an expert on something — what Buffett refers to as a ‘circle of competence’. If you can think critically about just one sector, you will have carved out a niche for yourself.
Bargains will always exist
Value investors are always looking for mis-priced assets. To invoke Buffett again, you need to be buying a dollar for 50 cents. There are several reasons why bargains will always be a feature of the financial marketplace. Firstly, because even in the computer age, the market remains governed by fear and greed. Panic sell-offs are always the best time to deploy capital. Moreover, these mis-pricings are often exacerbated by the presence of automated trading systems, as heavy selling triggers momentum traders. This is when the computers see selling in the market and respond by initiating selling of their own, which drives the price down further.
Secondly, assets become mis-priced because there will always be factors affecting price action that have nothing to do with intrinsic value. A large pension fund with a mandate to rebalance its portfolio at the end of a quarter is going to sell shares regardless of whether it makes sense to do so on a stock-by-stock basis.
I’m not saying that making money as an individual investor isn’t difficult. It is. I would go so far as to say that doing so today is harder than at some other periods in history — for instance, it is impossible for a retail investor to win by being fast — you can’t compete with a computer on speed. But it’s always been difficult. And for those concerned about the presence of high-speed traders today, consider that over the last 150 years, investors have had to deal with the introduction of the telegraph, the radio, and the landline. The way that people buy and sell is always changing, but the fundamental logic underpinning markets will always stay the same. Markets will continue to (sometimes) act irrationally and create excellent opportunities for individual investors willing to do the hard work of researching them.
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Neither Stepan nor The Motley Fool UK have a position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.