The Big Secret Wall Street Will Never Tell You About Investing | Smart Change: Personal Finance
There have been many studies that indicate that it is impossible to beat the market as an individual investor. Beating the market is extremely difficult, and only the best and brightest minds on Wall Street can achieve it.
So, if this is the case, who are the individual investors who believe they can make the remarkable feat of outperforming the larger market? Silly, isn’t it?
Probably. But before you write off investing in individual stocks, there are some flaws in this argument, you should consider that Wall Street doesn’t want you to know.
Using professionals as a benchmark for individuals is problematic because organizations have unique incentives that drive their business behaviour. The two main drivers are investor retention and performance-based rewards.
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In other words, fund managers need to generate high returns every year because if they don’t, they are likely to lose investors and make much less money than they were rewarded at the end of the year.
These are powerful catalysts for short-term gains. Meanwhile, there is no pressure on individual investors to achieve immediate results.
High turnover between funds
Ironically, the conclusion investors have to come to after hearing that more than 90% of fund managers underperform the market is that the pursuit of short-term gains is disastrous for long-term performance.
The main reason for this is the high turnover rate. Turnover is the change in positions within the portfolio. At The Motley Fool, we advocate low turnover, so your companies can build up for themselves in the long run.
In 2019, Morningstar found that the average local stock fund turnover was 63%. In other words, from the start of the year to the end of the year, the average fund’s holdings were 63% different.
Consequences of high turnover
As fund managers chase near-term results, there are real long-term consequences for their performance. The two main costs are the lack of compound interest and higher taxes due to short-term capital gains.
Compound profits are a byproduct of big investment, and should be the goal of every individual investor. Compounding occurs when you begin to reap a benefit on your interest. If you earn a 10% return on a $1000 investment, you will earn more dollars each year as your overall portfolio increases. Complications are hard to notice in the early years, but the results are dramatic after a few decades.
Very few fund managers have this advantage due to the constant pressure of chasing hot stocks. Herein lies a very real advantage for you as a retail investor: You are accountable to no one but yourself, and you have no outside pressure to chase hot stocks for near-term results.
In addition, a higher turnover results in taxes on short-term capital gains. These are the highest taxes you can pay on a stock sale. Unfortunately for fund managers, because they are chasing short-term results, they are often forced to sell shares, which leads to higher taxes. These taxes affect the real returns of the fund, which is another advantage for long-term investors.
Media pressure to invest like a pro
The more you deconstruct these studies on professional money returns, the more you will realize how beneficial it is to keep your winning stocks. However, the financial media is tempting investors into thinking that this is the game they need.
Take the logo from the famous Jim Kramer show money mad For example: “There is always a bull market somewhere, and I will try to find it for you.”
This indicates that individual investors should seek returns wherever they are in the market. Not only is this a stressful exercise, but it also removes the one advantage you have over foundations, which is time in the market.
Instead of trying to trade around these shifts in the market, investors should use it as an opportunity to buy quality companies on the cheap.
Wall Street is usually wrong about the big winners
Evidence of poor professional performance can also be seen in several big winners that Wall Street has written off as doomed.
Amazon (NASDAQ: AMZN) These are the most abundant examples. From headlines like “Amazon.bomb” to the countless critics predicting the company’s failure, Wall Street’s rejection of this huge winner is well documented.
However, Amazon’s total revenue compared to Standard & Poor’s 500 He speaks for himself:
AMZN Total Return Level Data by YCharts
Recently, Wall Street focused its criticism on the electric car maker Tesla (NASDAQ: TSLA). Doubts about the company’s ability to maintain its broad leadership in the industry as well as negative sentiments about its various disruptive technologies dominated headlines and talk show discussions.
Meanwhile, the stock has significantly outperformed the market over the past decade:
SPY Total Payout Level Data by YCharts
This is not a comment on Tesla’s business but further evidence that Wall Street has a track record of losing big winners.
Excellence lies in patience
When you elicit why institutional investors are underperforming, what you learn is that over-trading is horrible for long-term performance.
Instead of throwing in the towel because the pros can’t beat the market, you should conclude that you have a massive advantage by not having clients and year-end bonuses to influence your portfolio decisions.
Finally, whether it’s the short-term nature of Wall Street’s investment outlook or a general lack of optimism for new and shaky companies, the financial media’s track record of missing winners should only add to your conviction that you can…the market.
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John Mackie, CEO of Whole Foods Market, an Amazon company, is a member of The Motley Fool’s Board of Directors. Mark Planck has positions at Tesla. Motley Fool has positions at Amazon and Tesla and recommends them. Motley Fool has a disclosure policy.