It’s quite interesting how retail investors attempt to manage money like they’re a hedge fund. They don’t even realize the massive advantage that being a retail account provides.
They waste their time following fads, over trading, taking all-in or all-out positions, high concentration in single stocks. Now don’t get me wrong, I like single stock investments and concentrating on big bets, but when you’re trading 10 times a day out of your positions because Jim Cramer told you to, you’re doing something wrong. It’s like you’re asking Wall Street to take your money.
The Advantage of Size
Retail accounts have one of the greatest advantages in investing. They’re small. That means you can move in and out of positions without moving the price. You can take positions in small companies with little trading volume where inefficiencies are constantly appearing.
Institutions are forced to look at the large cap investments. And yet, retail investors insist on trying to beat the institutions by taking concentrated positions in the large caps. If you believe in any part of the efficient market hypothesis you would know that the large caps are probably the number one place where efficiency can happen. Millions of institutional investors are valuing the large caps to try to squeeze any alpha they can out of them.
Don’t get me wrong. I don’t believe markets are efficient, my portfolio is all the proof I need. But I understand that I’m not going to beat a bunch of analyst teams, data miners, quants, and the like. That’s their game and I don’t play in it because I know I’m going to lose.
So what should you do as a retail account?
Stop Playing the Active Game
Stop trying to invest actively in your entire portfolio. I am absolutely sure that if retail investors switched to passive exposure to what they think is happening they would immediately start outperforming.
ETFs are your friend. Let’s say you heard that interest rates are going up so banks and financials are going to benefit from the increase in interest payments. Rather than pinpointing a bank stock where business risk can completely ruin your position even if you’re right about the interest rate move, consider a Financials ETF like $XLF.
You’ll get passive exposure to the rising interest rate play. Eliminate the business risk of a single bank stock going against you. Somewhat professional management, ETFs are monitored more than they are “managed”. And if you’re wrong, you’re not going to blow up your account.
Stop Pulling Out
Another huge error that retail investors make is how they move in and out of positions. They are either all in or all out. The experienced money knows that it takes time for their ideas to play out and even then, they know they might be wrong. So how do they account for this? By gradually moving in and out of positions.
They decide to take a 10% position. Rather than buying 10% of their portfolio at once, they may buy 2%. Then if it goes down, they’ll reassess and buy 2% more. They’re lowering their cost basis and giving themselves room to be wrong.
Once their position plays out rather than moving themselves entirely out, the experienced money slowly sells out. They sell 2% of the position and see what happens. If their thesis continues to play out they’ll sell 2% more at a higher price. They may even use options to hedge against their positions moving against them while generating income for themselves.
Using this method means you don’t have to be right about your timing. Time becomes your advantage rather than your enemy.
Market Exposure: Beta
I like to get market exposure through an S&P index. The market tends to go up in the long-term so I usually have a long view. If we have a couple of big down days in the market I’ll increase my beta exposure by buying into the index or increasing my high beta positions. I’ll do the opposite on huge up swings. I’m not in or out, I increase or decrease my exposure.
When the market has a huge run up, I decrease my beta exposure by increasing my allocation to my alpha strategies which should generate an absolute return. Giving myself Beta exposure through a broad market index means I’ll be right in the long-term as long as the market and economy continues to grow, and it usually has.
Generating Alpha: Specialize in an Industry
If you’ve got the bug for stock analysis like me, allocate a percentage of your portfolio to your active strategies, then specialize. Specialize in an industry, sector — the more niched down you get the better — make it your life.
Learn about all of the companies in your industry, how do investors react (do they sell out when the dividend changes, do they freak out when a company announces an acquisition). You’ll find that you can start to pin point who is investing in what. That the same investors in this office REIT also like the apartments. When office REITs go up they move into the apartment REITs to stay balanced. This is knowledge you won’t get if you’re focused on all of the sectors at once.
This is what Wall Street analysts do. Rather than spreading themselves across entire indices they pick a sector and learn everything they can about it.
Don’t get bogged down if your sector stays flat. You can make money as long as the individual positions move up and down. I have yet to find an industry or sector in which the individual companies all move exactly together.
Wait for the Market to Tell You What to Do
Stop trying to predict the next market crash or Enron. Patience is an advantage. You don’t have to be in and out all at once. You can wait to get in, unlike Wall Street. Wall Street is forced to always have an opinion, they need to give buy and sell ratings and constantly be invested. As a retail investor you can wait on the sidelines as long as you want to get your opportunity.
Have a list of stocks on your watchlist with your thesis’ and target prices then wait to see what happens. Wait for big down days to buy your longs and huge up days to sell your shorts. Once a stock reaches your buy price slowly build your position. Wait to see what happens, then reassess. Did anything change, is the news short-term or does it fundamentally change the company.
Summary
Retail accounts have a huge advantage. They can take small positions, wait on the sidelines to strike, and don’t have to answer to anyone but themselves. You can easily beat the market by avoiding being stupid. You can take these strategies, build a portfolio to suit your risk, and even make a living for yourself doing this. You’ll be surprised how quickly your money can compound.
Leave a comment down below if you have any questions.
More To Come: I’ll be doing a series on risk management through options. Options, when used correctly, allow you to diversify and attain risk profiles you just wouldn’t be able to achieve through simple long and short stock positions.
