funds (e.g. ETFs – more on these later) means you will out-perform the majority of professional fund managers for a start.
But there can actually be an advantage in being small. You can gain access to corners of the market that are, effectively, closed to the average managed fund due to their size. I have spoken to many professional managers who accept that a particular stock may be priced to offer value, but don’t take advantage of the situation because the amount of the stock they could purchase would be totally insignificant compared to the value of their fund.
The famous investor, Jim Slater, when speaking about the merits of small companies, said:
“Elephants don’t gallop, but fleas can jump to over two hundred times their own height.”
I believe that small can also be good when it comes to investors as well as companies!
4. Invest in what you know
Peter Lynch, the American investor, is convinced that the average investor can out-perform the professional fund manager. He popularised the concept of “Invest in what you know”, which referred to the opportunity we all have in our daily lives to spot investment opportunities long before they are identified by fund managers looking at reports and figures.
He speaks about some of the best investments he has made first coming to his notice when he was driving around with his family or shopping at a local mall.
I believed in this concept long before I even heard of Peter Lynch and I have had the same experience. In a later chapter, I will go into some specific examples that should bring this concept as alive for you as it is for me.
5. Investing yourself is rewarding in many different ways
But there is more to all this than just money. Hopefully, as I have found myself, you will discover it can be fun, interesting and immensely satisfying to invest personally in the stock market. It also helps you to stay humble; on occasions you can be intellectually correct but still lose money!
I agree that if you constantly lose out in your stock market ventures it is highly doubtful you will stick around to appreciate these finer points. However, most of the long-term self-directed investors I know, who follow sensible rules, make money.
So, you’ve made the decision to invest yourself, but how practical is this?
Is it feasible to invest yourself?
The good news is that it has never been easier to manage your own investments. In this area, as in many others, the internet has changed things dramatically.
On websites today there is a wealth of information and research available to make investment selection and self-management far easier than ever before. But it’s not just about being a more informed investor. The websites also provide investors with many tools that make management and investment choice much easier and quicker. You can rank companies by dividend yield, earnings growth, PEGs – and much more. Stock filters that carry out searches for you for stocks that match whatever criteria that you want are understandably popular and extremely useful (don’t worry if you don’t understand all these terms, most will be covered later in the book).
The online platforms also allow you to deal at a fraction of the cost that used to apply. Dealing from £5 to £15 flat rates are now common. On the subject of dealing, it has to be said that the use of limits, stops and trailing stop orders make dealing much more effective and reduce risk. I will devote a separate chapter to this whole subject. These platforms make effective self-management of your investments a relatively straightforward task.
In summary investing in the stock market over the long term can have a very beneficial effect on your wealth! Controlling the investments yourself and making your own decisions has never been easier and is interesting and fun. In the long-term, annual management charges made by professionals make it entirely possible for the average layman to outperform them.
Why don’t you give it a try? If you have doubts, why not split your investments and measure your performance against the professionals. You may be surprised just how good you are!
Endnotes
1 Barclays Equity and Gilt Study (BEGS) 2010. [return to text]
2 BEGS 2010. [return to text]
Chapter 2: A Common Sense Approach to Investing
The application of common sense
As Warren Buffett once pointed out, investment is not a subject in which the person with the highest IQ will do best. I for one take great comfort in this view. I have always thought that investment is a relatively straightforward subject that is best kept simple.
It constantly amazes me how many people who are successful in their business lives seem to struggle when it comes to investing money. They should analyse why they have been successful in their own fields. Very few will have been technical experts. Most will have had a general interest in the area of the market concerned and would have adopted what many would describe as a common sense approach.
It seems to me many forget these principles when they enter the world of investment or decide, wrongly, to delegate the management of their money to people who are less able than they are.
Back to basics
Let’s go back to the very basics before we draw up some simple guidelines that hopefully will help.
When you buy shares in a company you become one of the owners of that business. The extent of your ownership is dictated by the number of shares you own compared to the total number in issue. The total value of a quoted company is referred to as its market capitalisation (often abbreviated to market cap), and this is calculated by multiplying the total number of shares by the current share price.
What’s in it for you?
As the part owner of the business you are entitled to two financial benefits:
1 A share of the current capital value of the business represented by the current share price.
2 A share of the annual profits. A proportion of these is often paid out each year as an income and is referred to as a dividend.
This being the case, you should ask yourself what type of business you would like to own. If you were buying the entire business you would undoubtedly think very carefully about this. You should do the same when it comes to buying shares.
Invest in what you know
Warren Buffett talks of this as the investor’s circle of confidence. It’s obvious, and only common sense, that the investor should focus on areas or sectors that interest them and they know best. At the very least the investor should appreciate what a company does and how it makes money. Often when I speak to investors about their shareholdings they have no idea what a company they own actually does!
The American investor, Peter Lynch, had a similar idea when he recommended investors to invest in what you know. He believes
