I know, there are many strategies for how to invest in equities-and all of them have advantages and disadvantages. One that i’ve heard is this “imitate the rich people”! basically, it goes like this:
-the rich (those with NAs> 10 $million), do NOT lose money. They pick strong earning companies, and do not do a lot of buying and dselling. their portfolios show good returns, and they don’t pay a lot in transaction costs (because their portfolios are so huge). Compare this with the small investor, who spends hundreds of hours studying stocks, and may try to hedge his poistions with puts and calls. Besides being risky, this philosophy requires a LOT of time and effort.
So are we all better off by just buying the stocks that the DuPonts, Mellons, and the rest of the ‘old money’ do? Is “active trading” simply NOT worth the risk 9in a small portfolio)? 
[will rogers]
Don’t gamble! Pick a nice, safe stock. Hang on to it until it goes up and sell it. If it don’t go up, don’t buy it!
[/wr]
In my opinion, stock picking, day-trading, technical analysis, and equity research done at the individual/amateur level are all 100% pure grade A hokum and therefore, a waste of time, unless you just enjoy that sort of thing for its own sake.
What isn’t hokum?
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Most people are risk adverse. For these people there is a benefit of holding a portfolio of stocks, but the benefit decreases rather dramatically with each new stock. Mutual funds and index funds take care of this for you.
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People have different risk preferences. One should carefully consider their attitude about risk and have their investments reflect their revealed preferences.
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No cite, but I’d bet the average return for people that hold a single mutual fund over 5 years beat the hell out of the average returns for people who spend 5 years pissing about trading in and out of positions with shorts and options and the like…including professional “traders.” Of course, the best performing active trader will beat the hell out of the best performing mutual fund holder, but for every success story you hear about, remember that no one likes to talk about losing their kid’s college fund at a cocktail party.
Monkey with darts.
agree-I’m just wondering if much has been written about the (relative) success of the very rich, in terms of equity investments. Take a family (like the Mellons) who have been rich for 5-6 generations. Do their portfolios consistently outperform the market? retained wealth must grow, or it will dissipate-so should we throw in the towel and just buy mutual funds?
“Buy low. Don’t Sell” ~ Warren Buffett ~
Tris
I personally buy and hold and have always regretted following the adage of “rebalancing” … do my personal picks outperform the market indices (which outperforms most mutual funds most years)? … by a smidge. My swings and miss have been just barely more than offset by my out of the parks and few plain solid hits. (Dang, I really expected Ballard to take off at some point!) But it’s more fun my way. 
(Then again I also have funds for the kids’ 529’s and a set of 501K retirement funds too.)
No, the average Joe (and that includes me) shouldn’t risk much of the pot on “active trading” if the pro’s can’t even usually beat the indices. An index fund or two, maybe one of those Schwab funds that have beated the index with some regularity, and maybe a bit in a few international funds for kicks. Then sit and keep adding in slowly over time. 529’s early for college savings (tax savings baby!) and pretax into retirement plans. That’s the ticket. The boring but effective ticket.
A lot of old money types own (and manage) companies rather than stock.
When I’m on a cruise, I spend a few hours at the casino’s roulette wheel. I go in with $100 knowing I’m going to walk away with $0, and roulette gives me several hours of solid entertainment.
Active stock trading is, to me, the closest thing to legalized gambling, and a heckuva lot of fun to boot. Odd thing is, though, that I’m up about 30% over the past 8 months, so I must be doing something right. But it certainly isn’t for everyone (an in-law has lost about $50K over the past year). The vast majority of my “wealth” is in my retirement plans in mutual funds.
Ultrafilter mentioned those with money owning companies (assumedly, private companies), and from my moderate business experience those returns will beat the general stock market by a huge margin - if you have the smarts to back the right companies most of the time. So, the rich get richer because they have more investment avenues available to them.
Rich people have the option of investing in hedge funds, which in and of themselves aren’t automatically a better way to invest but they invest in things other than stocks, like debt, options and derivatives. These things can be quite lucrative. It’s possible, for instance, to buy up the debt of a troubled company and leverage that into ownership of it. I think this is how ESL Investments took control of Sears and KMart.
Want to know the way to end up with a small fortune in the stock market?..
…Start with a large fortune.
I trade for a living at a professional firm. The differences between the trading environment where I work and what the typical retail customer on an E*trade account are huge.
Professional firms have rooms full of servers, direct access to exchanges, extremely efficient software, news right as it hits the wire, and access to enough capital to work effective strategies.
At my firm, no one I know trades based on fundamentals or technical analysis. It’s all based on the bid/offer book and “tape.” To a bad/new trader the order book looks like The Matrix zooming by. To an experienced trader, it’s obvious when Goldman Sachs is buying or there’s a computer program coming in every 5 cents buying 8,000 shares, then dropping out for 30 seconds, etc. It takes months of staring at the screen every day to be able to make sense of whats going on in a live electronic market. It’s more of a performance activity, as opposed to an academic one. Talented traders can most definitely destroy average market returns.
As for my own personal retirement account, I believe it’s smartest to invest for market returns, as opposed to managed mutual funds and picking individual companies. A bond index fund and stock index fund is all I need.
This poll will do better in IMHO.
[ /Moderating ]
I’m certainly open to the possibility that the “quant shops” can beat the market with the specialized tools that you describe, but I think the jury is still out. It’s difficult to prove either way. The fact that your outfit does doesn’t necessarily mean anything, you could have a survivorship bias, for example. That is, you don’t hear much about all the firms that folded or made spectacular losses (if they are out there).
If you get everyone in New York together once a year to flip coins, with those flipping heads allowed to come back next year, there will be some people who have flipped heads 20 years in a row. We wouldn’t say these people are good coin flippers, though.
At any rate, I would like to read some rigorous studies, which would admittedly be tough to do, as scholars aren’t going to have access to the proprietary tools firms haves spent big bucks on. In fact, I’d like to read a book or two on the subject, but it’s tough to find a book at Barnes and Noble that doesn’t want to tell me about trading strategies to make me a millionaire.
Thanks for the post; quite informative.
SNL Circa 1987:
When asked how he did so well in the stock market, Future Man answered the following:
“Read old newspapers. Go back in time. Buy low. Sell high.”
That’s what we have too.
One of my accounting professors does taxes and planning for very wealthy people. He’s described two strategies that he says have been fairly profitable:
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Buy when a firm announces a stock buyback. Do no research other than “they are buying back stock” Hold only for long enough to get into Long Term Capital Gains territory. Sell whether they are up or down - they’ll be up more often than not and usually enough to ‘beat the market’ - companies don’t buy back stock unless they think its a good investment, and who knows better than the company.
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Buy stock when a split is announced. Hold the same, sell the same, same rationale.
I have no idea if either of these works, nor am I recommending them. I’m mostly in index funds, too.
Best way in my opinion is to do it within your 401(k). Your plan should have some mutual fund options, pick the one that looks best for you in terms of risk/reward. All the funds have managers that have forgotten more than you or I will ever know about investing. Use their expertise and let them go at it. Since it’s a 401(k), no tax on any earnings or even your contributions until retirement. You have an immediate return in that your tax bill is diminished, any earnings you make is gravy on top of it.
Dangerosa, I don’t know about #1, but my Finance professors showed us a study suggesting that #2 doesn’t work. It’s actually a pretty humorous graph, you see this big run up in stock price, then the announce date, then it’s flat afterwords, as if announcing a split spoils the gains you’ve been getting. The reality is, of course, that companies only announce a split after big gains, so you’re selecting only companies that had big gains prior to the announce date, then analyzing the returns after that date, which are pretty much average market returns.
smeldmf mentioned the really key point here. There are people out there who spend all day every day doing nothing but trading stock for profit. You are not going to out think or out research or out trade these people, and on average they don’t really beat the market, not by much anyway. Trying to go toe to toe with these guys by researching individual companies doesn’t make sense.
Look at your “rich person” strategy
Buy strong earning companies, don’t trade a lot, have low transaction costs, diversify your portfolio (I added that last one). This is also called “buy and hold an index fund”.
It’s not exciting, or flashy, or all that interesting, but it’s an excellent strategy for the small investor.
On preview, I’m not a big fan of actively managed funds. You have to pay for Mr Bigshot and his staff to manage the assets, and there’s more turnover in the fund makeup, so the funds cost more to own than index funds, and there’s still no guarantee they will beat the market.
- Buy and hold
2)You cannot time the market - Diversify
- You cannot time the market
- Get rich slow
- You cannot time the market
Almost all the rest is the fact that historically, the stock market rises.
Regards,
Shodan
Invest in a mixture of index funds and use all the tax advantages with regards to retirement savings you possibly can (which will differ based on your country of residence.) Sock it away every month and don’t touch it until you retire.