Retail vs. Institutional Investors: Compare and Contrast

My recent post concerning the challenges of being a retail investor, especially when using strategies and approaches generally the province of Institutional Investors, caused quite an (unintended) stir. My piece was designed to highlight the risks associated with being a retail investor and wading into complex territory, and to make a recommendation for keeping the core of one’s strategy brutually simple (and cost-efficient) while leaving some room to stretch for outperformance. A common thread running through the more critical comments I received were of the nature “Well, how can you write this when Institutional investors (read: hedge funds) have been doing incredibly stupid things and losing boatloads of money? Isn’t it arrogant of you to say that retail has problems when institutions have plenty of problems of their own?” Answer: yes I can write this and and no it’s not arrogant - they are two different issues entirely. But since I clearly left some ambiguity on the table, let me clarify and be more precise about a few things:

1. When I say “retail investor,” I mean an individual for whom investing is not a full-time vocation; it is a necessity and/or a hobby;

2. Institutional investors are those for whom investing is a full-time vocation, enabling them to spend more time doing research then even the most talented of retail investors. Further, most Institutional investors make a goodly living off their vocation;

3. When I discuss the frailties of humans as investors, they apply to both retail and Institutional investors; it is only that a small subset of investors. be they retail or Institutional, have the ability to overcome these frailties; and

4. When I talk about discipline, the challenges of remaining consistent and sound in one’s strategy applies equally to both retail and Institutional investors.

Ergo, carrying a card that reads “Institutional Investor” does not somehow imbue you with skills and abilities that automatically make you successful, just as being labeled “retail” does not, by definition, correspond to the word “idiot.” My belief is that almost all investors, be they retail or Institutional by stripe, are not good. Those who can generate true, sustained, statistically-significant outperformance over long periods of time are rare. No, more than rare. But I care less about the failures of Institutional investors as people because they, quite frankly, make a lot of money as a group, while retail investors span the economic strata. This is why I choose to write about retail and my wish for them, as a group, to think smart, be humble, and take a rational and serious (read: “This is not fun - this is business”) approach to investing. If this is arrogant, so be it. Excuse me. But I think someone without a vested interest needs to write this stuff because it is a perspective too often lost amidst the hype.

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COMMENT:

AUTHOR: kotika

EMAIL: kotika98@yahoo.com

URL: 

DATE: 08/23/2007 02:31:49 PM

The WSJ article didnt name those people for what they really are, idiots. WSJ is a classy act and does not need to call people names, and its readers an intelligent bunch so they can make their own conclusions.

 Having said that, the article did have a misinformed angle, which i also detect among peoples comments in response to your post. The key to making money in the long run is putting on trades which make money “on average”. Everybody knows that picking a random stock and going long is going to make you on average 10% richer same time next year. But the same knowledge is not readily available for any other asset classes, the real difference between a pro and an amateur is that the pro has either been told what the average return from an asset is, or even better has been schooled to make an estimate of his/her own.

  For example GS has taught people recently that being long commodity futures brings in a 17% return in the long run. Investors who dont know how to make their own estimate of the future return inevitably have to rely on this measure of the past (irreproducible i.m.o.) return. This is why the institutional scene is susceptible to crowding, people do talk and eventually any good invesment becomes not so good when billions chase after the same strategy.

 But the amateur is different, perhaps because he mistakenly believes that the market is a zero-sum game. He tries to improve either his timing, or  picking skill which is really futile exercise, instead of learning to make long-run estimates of the returns of various assets.

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3 years ago | view comments |  Investing