In his book, One up on Wall Street Peter Lynch explains the simple reasons you can outperform the fund managers and professionals on Wall Street.
“When you pick your own stocks you should outperform the professionals otherwise, why bother?”
Peter Lynch
Here we will discuss the advantages of the average investor and the weaknesses of the professionals.
Advantages of the Average Investor
The biggest advantage the average investor has over the professionals is that they can discover products and invest in the companies that produce them long before they appear on the professional’s radar.
“You can pick spectacular performers from your place of business, or out of your neighborhood shopping mall long before Wall Street will find them”.
Peter Lynch
Lynch stumbled upon many of his biggest winners accidentally. He was impressed with the Taco Bell Burrito, he loved staying at the La Quinta Motor Inns, his kids had an Apple computer at home and they used Apple computers in his office. He discovered these products during his day to day life, not in an investing newsletter, from a ‘hot tip’ or in a finance article.
His wife discovered the product L’eggs, made by the company Hanes. His wife didn’t need to be a security analyst to realize that L’eggs was a superior product to the competition, she just needed to try them. L’eggs hadn’t come up in Lynch’s research and it may never have if it wasn’t for his wife.
“Visiting stores and testing products is one of the critical elements of an analyst’s job”.
Peter Lynch
Why wait for the analysts to tell you about Starbucks when you have already noticed four new franchises in your local area. The analysts aren’t going to notice Starbucks until it has gone from $2 to $10. You could notice it when it’s still at $2.
Weaknesses of the Professionals
“70% of the shares in major companies are controlled by institutions”.
Peter Lynch
He said that in 1989, that percentage is closer to 80% now according to www.pionline.com. This means that you are always competing with professionals. It would be nice to know the weaknesses of your competition.
The majority of professional fund managers are restricted by rules either imposed by the SEC or the fund itself.
The fund can impose rules on itself such as only investing in large-cap stocks or specific industries. Maybe they are only allowed to buy ethical stocks. The smaller the list of stocks that the fund manager can choose from the less likely they are going to find the big winners. The average investor can invest in just about any stock they want.
The SEC has rules to protect companies and the fund’s investors. The SEC says a mutual fund can’t own more than 10% of any single company. Mutual funds have a lot of money to invest. This means they will only be able to invest in the largest publicly traded companies. A fund with $10 billion under management wouldn’t waste their time investing in a company with a $10 million market cap. Even if the stock appreciated 10 fold the return compared to the overall portfolio would be minuscule.
Mutual funds can’t invest more than 5% of the funds total capital in a single stock. This means that when a fund manager finally finds a stock with great potential they can only invest 5% of their available money in it. They would need to find 20 stocks if they are going to invest 100% of the fund’s money. The average investor doesn’t have this problem. They could invest all their money in one stock if they wanted to. It’s a lot easier to find 5 or 10 great stocks than it is to find 20.
Most fund managers are afraid to take chances.
“You’ll never lose your job losing your clients money in IBM.”
Peter Lynch
A fund manager may lose their job if they risk their client’s money on unknown stocks. They are a lot less likely to lose their job losing their client’s money in a well-known stock. This encourages lemming-like behavior with each fund manager investing in the same basket of stocks.
“You haven’t spent much time on wall street if you think that the average wall street professional is looking for reasons to buy exciting stocks, the rare professional has the guts to buy into an unknown company,”
Peter Lynch
Most fund managers are happy buying the same mediocre, well-known stocks as all the other fund managers. This can only lead to mediocre results. For the average investor, their job isn’t on the line. They have no one to impress, and there’s no one breathing down their neck. The average investor can invest in whatever they like.
Summary
The average investor has many advantages over the professional investor which could allow them to outperform the professionals.
- The average investor can find stocks long before they appear on the professional’s radar. You can find many of these stocks at work or your local shopping mall.
- The professional fund manager may be restricted by rules imposed by the fund itself.
- A mutual fund can’t own more than 10% of a single company. This means they are restricted to investing in only the largest publicly traded companies.
- The average investor can invest in companies of all sizes.
- Fund managers can’t invest more than 5% of the fund’s money into a single company. This means they must find many different stocks to invest in.
- The average investor can invest in as many or as few stocks as they want.
- Many professional investors are afraid to take chances on unknown stocks. If they do and it doesn’t pay off they may lose their job.
- The average investor doesn’t have to worry about losing their job if they make a bad investment. This gives them the freedom to invest in more speculative stocks.
If you would like to read more about how the average investor can outperform the professional that get yourself a copy of One up on Wall Street by Peter Lynch. (affiliate link)
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