The 2-Minute Thought: The Best Way for Individual Investors to Compete

Individual investors often forget that active investment is a competition.  It is you against the person on the other side of the trade.  If you are buying, you should always be thinking about what the seller knows that you don’t.

Michael Mauboussin and his colleagues Dan Callahan and Darius Majd at Credit Suisse wrote as much in a January piece called “Looking for Easy Games.” 

Active investing, they said, is not unlike being invited to play a game of poker.  Before you agree to show up, you should ask who else is coming.  You will be happy to play if you hear the other players are rich and have poor poker skills.  But you should think twice if you hear the other players are highly skilled.  It is still possible you could win against more highly skilled players because of the element of chance.  But you should know it will be a hard game and may well choose not to take the risk of showing up. 

The point is that smart investors should look for easy games.   Likewise, they should be smart about avoiding hard games.  Hard games might include forecasting quarterly earnings or making macroeconomic predictions.

Easy games might include focusing on what other people don’t care about – and staying away from what’s most talked about in the news.

Source: Financial Times

Source: Financial Times

The Financial Times not too long ago split the FTSE 100 into the companies mentioned most in the news and the companies mentioned the least.  Take what you will from the period of time shown, but the companies who seldom merited mention in the news and were quietly doing their work did a lot better than those that were always in the news (the low-profile companies are called “the XFT index” and outperformed by 33%).

 But there is an even better way for individual investors to play an easy game.

That is to lengthen one’s time horizon in an investment world so focused on the short term.  Few investors seem to have the wherewithal to stick it out for a year or three let alone five.  But individuals who look out much farther can play a completely different game from the vast majority of investors out there.  Jeff Bezos, founder of Amazon, put it this way in his interview with Stephen Levy at Wired Magazine:

"If everything you do needs to work on a three-year time horizon, then you’re competing against a lot of people.  But if you’re willing to invest on a seven-year time horizon, you’re now competing against a fraction of those people, because very few companies are willing to do that.  Just by lengthening time horizon, you can engage in endeavors that you could never otherwise pursue.”