Investing: Professionals vs. Individuals

I have heard many myths that claim the small investor shouldn’t waste his time and money, but some of the most annoying are the following:

Why should individual investors even try? After all, how can they outperform professional investors?

– or –

In any trade, one of the two parties is the fool, so if you are uncertain which is the fool, then the fool is probably you.

Common sense alone is sufficient to see through these myths, but a little general knowledge of the economic reality can help to further debunk them.

First, note that many small investors are ineffective for many reasons, but being a small investor is not one of those reasons. It is actually an advantage.

Some advantages of large investors are vanishing; whereas, many disadvantages have always existed. Also, small investors don’t have to outperform large investors to make a profit.

Some examples of why small investors don’t have to outperform large investors to make a profit are:

  • Small investors are also competing against other small investors.
  • The best small investors are clearly better than the worst professional investors.
  • It is not a zero sum game. Suppose CDs, bonds, and savings accounts will give you anywhere from 1% to 5%, so you buy an asset because you will make 10%, and the seller is another small investor who actually is making a better decision than you because he will use that money to buy another asset that will make 20% profit, and suppose that small investor bought that asset from a professional who will use the money to buy an asset that will make him 30%, etc.

Examples of how some advantages of large investors have been vanishing are:

  • Small investors now have far more information thanks to the Internet.
  • Commissions on small trades are now about 80% cheaper than 20 years ago.
  • Small small investors can perform trades as quickly as professionals now.

The disadvantages of large investors that have existed much longer than 20 years can be summarized as how small investors don’t have the constraints of large investors. For example:

  • Large investors have to find a place to put more money, so they can’t just put it all in their first choice.
  • Small investors are free to take their money off the table when there are no good options for them (or even to invest in their education or health) until financial investments become worth their effort again; whereas, professional investors must always choose some financial investment.
  • Small investors are free to admit that they lack insider information, publicly available information, natural intelligence, competence, etc.; whereas, professional investors would lose their job if they admitted any of these things.
  • Professional investors have to spend a lot of time dealing with corporate politics, such as other professionals trying to torpedo them.
  • Professional investors must be more conservative. A single embarrassing investment mistake could be the end of their career.
  • Professional investors cannot afford to look as if they are going against the experts or the crowd, so they cannot risk exposing themselves to alternative news, conspiracy theories, etc. or else they might believe some of it, and if they believe some of it, then they might repeat some of it, and if they repeat some of it, then they will lose the confidence of their clients and/or employer, which is a disadvantage because:
    • The mainstream is often wrong:
      • Economics professors are usually wrong.
      • Economists are usually wrong.
      • Economics is mostly about politics rather than science.
      • The newspaper of record (the NYT) is usually wrong about economics.
    • The alternative media is often right:

  • Large investors therefore act within a narrow range; whereas, individuals are free to think outside the box.
  • Small investors can thus act based on the conformism and (thus predictability) among large investors; whereas, large investors cannot depend on conformism among millions of individuals each having a different world view, different risk threshold, and who are free to think outside the box.
  • Individual investors live in the real world; whereas, large investors live in an artificial world.

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