How you can beat the investing professionals

So… the ASX has slumped, again, plunging 90 points on Wednesday or 1.9%.

Monday it was also down 1.9%. Tuesday it soared 2.6%. As for Thursday, early indications are the ASX will move higher on the back of Wall Street’s overnight gains, but it really is anyone’s guess…

It was too much for one poster on The Age‘s daily Market’s live blog…

“The schizophrenic and dubious behaviour of the ASX 200 over the past 5 years has caused a whole generation of potential investors to abandon the sharemarket. Well done to the immoral and impatient short traders and fickle overseas investment houses.”

Comments such as the above from “Rob of Eaglemont” are music to my Foolish ears.

Not because investors are abandoning markets, but because instead of running away from volatile markets, I embrace them, and the irrational share prices they offer long-term investors like myself… and hopefully yourself too.

Cashed up and trigger happy

As regular readers will know, I’m cashed up and trigger happy.

I’ve got my eye on BHP Billiton (ASX: BHP) should it fall below $30. Today could be my lucky day. Wednesday it slumped over 3% to close around $31.

Portugal and Greece are back in the news. Panicked investors are running for cover. For me and BHP $30, it’s just a matter of time.

Over to Morgan…

How You Can Beat The Professionals, And Make An Investing Fortune
By Morgan Housel

The so-called professional’s edge over you seems to tighten by the hour.

Insider trading is rampant. High-frequency traders can see your trades before they’re even executed. CNBC reported last week that Thompson Reuters sells the results of consumer confidence reports to select professional investors as little as half a second before the data is made public — that’s all they need to gain an edge.

“Why shouldn’t I just give up?” a reader emailed last week.

I’ll tell you why.

Your giant advantage

Individual investors have a giant advantage over professional investors, and they might not even know it.

What is it?


You’re trying to fund your retirement over the next 20 years. Fund managers have to woo their clients every month.

You’re saving for your kids’ education over the next decade. Fund managers have to fret about the next quarter.

You can look years down the road. Traders have to worry about the next ten milliseconds.

Most professional investors can’t focus on the long run even if they want to. As Henry Blodget put it:

If you talk to a lot of investment managers, the practical reality is they’re thinking about the next week, possibly the next month or quarter. There isn’t a time horizon; it’s how are you doing now, relative to your competitors. You really only have ninety days to be right, and if you’re wrong within ninety days, your clients begin to fire you.

I’m a long-term investor. I’m not going to fire myself because of a bad quarter. The fact that you and I don’t have to play these insane short-term games is the last remaining edge we have over the professionals.

And frankly, it’s enormous.

The biggest risk investors face is losing money between now and whenever they’ll need it — likely retirement. The good news for you — and bad news for the professionals — is that the odds of losing money drops precipitously the longer you’re invested for.

I took monthly S&P 500 prices going back to 1871, adjusted them for inflation and dividends, and looked at returns based on various holding periods.

Do you feel lucky?

Holding stocks for less than a year amounts to little more than flipping a coin. You are almost as likely to lose as you are to win.

But the odds of success grow perfectly with time. If you hold for five, 10, 15 years or more, the odds of earning a positive return on stocks after inflation quickly approach 100%, historically.

This chart shows the percentage of holding periods that generated positive returns:

Source: Robert Shiller, author’s calculations. 1-day returns since 1930, via S&P Capital IQ.

The irony is that while the professionals have more information than you, their short time horizon forces them to deal with more randomness than you have to.

That’s your edge.

And it’s why any bumpkin who buys an index tracking fund and forgets about it will beat the vast majority of professional money managers over time.

Here’s another way to look at this. This chart shows the maximum and minimum annual returns someone would have earned between 1871 and 2012 based on different holding periods:

Source: Robert Shiller, author’s calculations.

How to never lose money in the stock market

Hold stocks for a year (the professional’s territory) and you’re at the mercy of the market’s madness — maybe a huge up year, or maybe a devastating loss.

Five years, and you’re doing better.

Ten years, and there’s a good chance you’ll be sitting on positive annual returns.

Hold them for 20, 30, or 50 years, and there has never been a period in history when stocks produced an average annual loss.

In fact, the worst you’ve done over any 30-year period in history is increased your money two-and-a-half fold after inflation. The professionals would love to think about those numbers. Alas, it’s busy chasing its monthly benchmarks.

You have the opportunity to focus on the long term. The question is, Will you?

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