The Individual's Advantage

We have pointed out the many reasons that institutional investors have advantages over the individual investor, but there are some important advantages that the individual does have.




Flexibility


Individuals have more flexibility in their asset allocation than institutional investors with a mandate to stay fully invested within their asset class.  An individual with some insight into the market can pull money out of stocks when he or she senses overvaluation in the market while an institutional investor, say a mutual fund being bench marked against the S&P 500, doesn't have the freedom to reduce exposure or stray too far from their fund's stated style.


Individuals are also not forced to diversify their investments across hundreds of stocks.  An individual who takes an active role in managing their investments can earn superior returns by picking 5 to 10 stocks to initially research, invest in, and follow closely.  This is the approach followed by Warren Buffett (who prefers to buy whole companies, but does make large investments in individual stocks like KO, IBM, and others) and many hedge fund managers who are seeking absolute returns (vs. many mutual funds who invest to simply beat the S&P 500 by a slim margin).


Small Cap Stocks


Individuals can do their research on under-covered small cap stocks that could be significantly undervalued given their fundamentals.  Most large institutions aren't be able to make meaningful allocations to the small cap stocks without "moving the market" against them and large ownership stakes in a single company come along with additional filing requirements.  It's easier for the institutions (and investing public who place their funds with them) to blindly follow the Efficient Markets Hypothesis and invest in the market as a whole while largely ignoring small cap stocks that have traditionally outperformed even on a risk adjusted basis.




Options Strategies


Individuals can employ options strategies on a small scale that institutional investors wouldn't be able to utilize where there are small contract volumes.  The individual can take a view on a particular stock without actually buying (or shorting) the stock using options strategies to gain exposure or even reduce exposure to a stock in their portfolio.  My personal favorite are strategies that pay me a premium to take some defined risk over a short time period and with a comfortable margin of safety.




Alternatives to the Stock & Bond Markets


There are also a number of alternatives to investing in the stock market that are available to individuals, some can be time consuming while others don't take much more effort than making your 401k or IRA allocations.  Some of the popular asset classes besides stocks and bonds are: Real Estate (Income Property), Commodities, Loans (to individuals or businesses), or an investment in a real business.  Investing in these alternatives often requires a large amount of capital upfront and/or some knowledge of how to execute an investment which most individuals don't have.


There have been some innovations in this area helped along by the social web (and there are more to come I am sure).  One of these innovations I have been following closely over the last 5-6 years is P2P or Person to Person lending which involves individuals lending in small increments to other individuals (here in the US Prosper & LendingClub are the leaders), there are even some "Crowdfunding" websites on the way (pending a bill currently before Congress) that will let individuals invest in start ups in small increments.


Please feel free to leave your comments, topic suggestions, or questions and I will answer what I can either in the comments or with a new post.  There will be more to come on all these opportunities to earn great returns, stay tuned!