4 Surprising Nuggets for Retail Investors

Feb. 29, 2024

There's more than one way to skin a cat, and there's more than one way to have good investment performance.

In the short term anyone can win, in the long term it's more difficult. Investing can be both beautiful and ugly. Beautiful because anyone can participate and ugly because anyone can participate.

As famous investor Joel Greenblatt highlights: "Choosing individual stocks without any idea of what you're looking for is like running through a dynamite factory with a burning match. You may live, but you're still an idiot."

So what can retail investors do in their quest to pick good stocks?

Below is some nuggets that most investors find surprising and being aware of them might help you in your investment journey.

1. Value vs Growth

One of the most surprising findings to stumble upon, is the finding that value strategies outperform growth strategies over the long term.

For new investors, this is almost unfathomable especially given the recent 10 year plus bull market.

A possible reason for this consistent finding is that investors tend to extrapolate. Essentially, investors are too optimistic about growth stocks and too pessimistic about value stocks.

2. Loss vs Gain

The best investors in the world focus more on the downside than on the upside. They don't want to get punished when they make a mistake. 

Ben Graham called it "the margin of safety".

Warren Buffett has two rules: "Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1."

Other famous investors that frequently talk about focusing on the downside include: Howard Marks and Seth Klarman.

Mathematically, it's quite simple, a loss impacts an investor more than a gain. If a stock drops by 50%, the same stock needs a gain of 100% to arrive at breakeven again.

3. Size

Another consistent finding in the literature is that small illiquid stocks outperform large liquid stocks.

This might seem interesting, I mean some of the biggest stocks in the world include: Apple, Microsoft, Google and Amazon. Although these are some of the best businesses in the world, it is not necessarily the best business for the best price. 

Not one of the top 20 companies by market cap in 1989 are still on the list of today's top 20 companies by market cap Buffett recently highlighted this.

In terms of liquidity, it makes sense that an asset that is traded a lot more will be priced more efficiently. An investor look to buy land in New York is pretty sure what a reasonable buying price might be, however, an investor looking to buy land on Mars is more unsure what a reasonable price might be. Going small and illiquid means that your opportunity to gain from market inefficiencies are higher.

4. Cash is trash?

The last one is quite contentious, popular consensus is that investors should be 100% invested at all times and follow a dollar cost average strategy.

This is an easy and practical strategy to follow. Also, being fully invested in equities during a bull market will most likely outperform.

However, consider this, what separates you from a professional portfolio manager, an institutional investor or an ETF if you follow this strategy? These mentioned investment players do not buy stocks based on the value of the business or the share price, they buy according to asset allocation with a mandate to be 100% invested. 

A retail investor should always ask what can I do that big players can't do?

Seth Klarman puts it quite nicely:

"When you buy anything it's an arrogant act. You're saying to markets are gyrating and somebody wants to sell this to me and I know more than everyone else so I'm going to stand here and buy it. That's arrogant,"

Suppose you want to follow a 100% dollar cost average investment strategy and you decide to buy 10 stocks which you plan to hold for 10 years. What you are implying with such a strategy is the following: "I know more about these stocks than the market do for the next 10 years!"

Even Buffett decided to close his partnership in 1969 after achieving an astounding 29.5% annual return for more than a decade because he felt the market was too expensive and he felt that couldn't buy more stocks.

So, a portion of your portfolio in cash can help you take advantage of market selloffs. It might be difficult to hold cash when we are in a bull market, but it helps to lower risk when bear markets happen like the current environment.

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As the title suggests the points discussed are tidbits to think about, not the rule of law.


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