What are the advantages and disadvantages individual investors have relative to professional investors. How individual investors can capitalize on their advantages without being overwhelmed by too many choices.
Topics covered include:
- How much have fees and commissions dropped for individual investors in the past two decades
- How the overall objective of individual investors differs from professional investors
- Why the smaller scale at which individual investors operate provides an advantage relative to professional investors
- What are some advantages that professional investors have relative to individual investors
- How having constraints and rules of thumb allow individual investors to generate better returns and be less overwhelmed
- What are some examples of rules of thumb that collectively form an investment philosophy and process
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Welcome to Money For the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today is Episode 354. It’s titled “Now Is the Best Time Ever to Be an Individual Investor.”
I spent just over 15 years as an institutional investment advisor and capital allocator, including time managing overall portfolios for endowments and foundations in what is known as Outsourced CIO services, or OCIO. I was our firm’s Chief Portfolio and Chief Investment Strategist. I also co-led a research group that conducted due diligence on asset managers across numerous market segments, including stocks, bonds, real estate, private equity, energy, timber, and hedge funds. I held numerous manager meetings, many at these firms’ offices. I’ve spent a lot of time with asset managers. I’ve also been an asset manager, but I’ve also been an individual investor, as I stepped away from institutional asset management about a decade ago.
There’s a difference between being an institutional professional investor and a retail individual investor. There are advantages and disadvantages to each, but there has never been a better time to be an individual investor.
Lower Investment Costs
Product fees for ETFs and funds have never been lower.
ICI reports that in 1996 the average equity mutual fund expense ratio was just over 1%. As of 2020, it had fallen to 0.5%. Expense ratios of target-date mutual funds are 45% lower today than they were in 2008.
Morningstar reports that the asset-weighted average expense ratio across all US open-ended mutual funds and ETFs has been cut in half over the past two decades. That average asset-weighted expense ratio is now about 0.45%. Commissions are free for many trades on stocks and options. One of the first trades I did back in the early 90s, the commission itself was $40. As an institutional investor, I envied institutions that could trade at 1–2 cents per share, while we, as retail investors, were paying $5 to $10 per trade. Now, it’s free. There is a proliferation of ETFs, which provide greater tax efficiency for retail investors; the number of platforms and funds available has exploded.
Individual Investors Operating at a Smaller Scale
I prefer being an individual investor instead of an institutional asset manager; much less stress, certainly much less travel, and much easier. There are definite advantages individual investors have relative to professional investors, even though professional investors might have access to better tools. There are some advantages to being smaller, to operating on a smaller scale.
I was reminded of this when a listener to this show who is a medical doctor sent me a research paper he co-authored that was inspired by some of the episodes that we have done on Henry David Thoreau, episodes 240 and 278, for example. Their paper was titled “The Reel Deal: The Stacked Benefits of a Reel Mower.” By reel mower, he’s referring to a manual push mower. And he introduced a term I had not heard before called “mow-lawning”. It’s a term of actively cutting grass using a reel mower, typically faster than your normal pace, in order to get some of the exercise benefits and reduce the amount of time it takes to mow.
It’s not practical for a professional landscaper, given the lawns they have to cut, to use a manual push mower. But for an individual, with just one lawn, you get the health benefits, the cost savings, the environmental benefits, and the satisfaction. Those are the stacked benefits of cutting your own lawn with a manual reel mower.
Similarly, we can do things as individual investors that are not available to professionals. Because we operate at a much smaller scale. It’s just not practical for a professional investor. Foremost is liquidity. Institutional investors spend a lot of time worrying about can they get in and out of a particular investment without impacting the price. Their trades are much larger than the trades that we place as individual investors. That allows us to get into specialty segments of the market such as closed-end funds, which are notoriously less liquid, but you can buy at significant discounts to their net asset value. We discussed closed-end funds in Episode 290. And there’s an investment guide to closed-end funds on the Money For the Rest of Us website.
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