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Another Big Reason Not to Invest in Individual Stocks

Maybe you’ve figured out a way to get around transaction fees and so you won’t be losing money every time you trade. So you figure you’ll take a chance on your smarts, the financial news, and trying to invest in the biggest stocks.

It’s possible, but here’s another reason why it’s likely to fail.

I’ve been reading Confessions of a Wall Street Analyst: A True Story of Inside Information and Corruption in the Stock Market (affiliate link) by Dan Reingold, formerly one of the top two telecom analyists.

There’s a lot of points to Dan’s story, which takes place on the Street during the rise of the telecom/dotcom bubble and then as it popped. It seems very straightforward, though one can’t help wondering if the author is making some editorial decisions to make himself look better. I know it’d be tempting.

Anyway, the point I want to address is insider analysis. Yes, there were insider trading issues at that point too, but let’s focus on analysis, relationships, and whatnot.

These analysts had the advantage of being in the room when a CEO threw out a hypothetical question which made them all feel that his stock was going to sink. They were able to read his body language and catch his nervousness and attempts to cover it. Some immediately told the funds they managed to short sell his stock or just plain sell it. They didn’t think it was due for an immediate crash, but they knew things weren’t good.

You and I, my dear investing friend, don’t have that advantage. We aren’t “Fido” (Fidelity), who gets an early-morning call just as the market is about to open with the news that our analyst is downgrading his valuation of this stock. (Maybe something happened like in the CEO case or maybe because s/he’s a good analyst.)

Basically, not only are we not trained, but we’re not there. And we’re not friends with people who will give us non-insider information to help us make good decisions. We can’t afford their services.

Instead, by the time we hear about the company’s problems, the stock will have already fallen several dollars. We may not be able to recoup our initial investment.

Let me contrast that to someone owning a Fidelity fund. The managers get the analyst’s call and report early that morning. They take it into consideration with all the info they’re receiving from other people and their own knowledge of the market. There are hundreds of trained people doing this. And then the person/people responsible for the fund decide to alter its balance.

The fund isn’t affected (or is less affected) by the drop in price. They got the news sooner. They were better prepared to act on it.

And that is why we want them managing our stocks.

Personally, I’m an S&P girl–which means relying on a certain data set and just tracking the market (well, I’m going to get more in depth about the S&P in the future!). But actively managed funds at reputable organizations definitely have the edge over individual investors (unless, say, you’re as rich as Bill Gates and can hire people in the know to help you pick your investments).

Buying funds is our way of hiring expensive analysts.

Disclaimer: Once again, Mrs. Micah can’t guarantee any funds or any course of investing. If you need investing advice, please consult a professional (thought for goodness sake take what they have to say with a grain of salt too!). This is just my take on the way the market works.

photo by Agent Smith

{ 5 comments… read them below or add one }

RacerX December 19, 2007 at 2:15 pm

Mrs M,

Another great reason to follow an axiom from Warren Buffet, “Invest in what you know!”

OR if you don’t directly have involvement with an industry, learn about an area you like; Food, hotels, transportation, farming πŸ™‚

Be your own expert. By the time anyone hears the news it is probably factored into the price! It is another reason why I like EFTs. With so many options, you can buy what you know, but spread some risk.

Swamproot December 19, 2007 at 6:11 pm

Personally, I wouldn’t put that much stock in a broker “being there” (pun intended). The more I read the more I am convinced that almost any success of active management is an illusion and the lucky result of mere speculation. Knowledgeable and experienced speculation to be sure, but almost always speculation. I would be that for every time Mr. Reingold successfully “read a CEO’s body language”, he ate four heaping bowls of “Boy, wasn’t I just full of shit”.

IMHO, Your best hope is to find someone WHO WILL PAY YOU millions of dollars to learn about proper asset allocation diversification across non-correlated asset classes. (S&P indexes are mostly only one: Domestic Large-Cap Value, with some Growth thrown in).

Where do you find such a person? In the mirror, you’ll just have to wait until your sixties to get paid for it. πŸ™‚

mrsmicah December 19, 2007 at 6:18 pm

Well, I’m definitely more pro simple indexing myself. But I think it’s another important point to those who think they can guess and time the market. Whether it’s being in the room when a CEO gets upset (and everyone reacts by selling) or having spend 20 years analyzing the stock, analysts probably have a jump on them.

I don’t think highly enough of analysts and fund managers to give them my money, but I think they probably know more than I do. I just don’t think they’re good enough. πŸ˜‰

Becky December 19, 2007 at 10:36 pm

I’m personally a big fan of American Funds, which are actively managed. They’ve done really well historically and have low fees for an actively managed fund. I agree, leave the stocks to the pros!

Swamproot December 20, 2007 at 11:24 am

I was just saying you should diversify your index funds past the S&P. Have some in there and some in an international index. Some in a Russel 2000 based index.

You could certainly do worse than American Funds. They are the only choice I have in the SIMPLE-IRA I have at work and comprise the majority of my own meager assets.

However the realization that their front loaded funds start me several percentage points in the hole every month has led me to take more control over my retirement spending “above the match”. They are why I opened a Roth IRA at T. Rowe Price and plan on opening a traditional IRA at Vanguard.

Plus they are the epitome of style drift. The Growth Fund of America is 20% foreign! But that’s not to say I don’t have it in my IRA at work. And actually not in spite of the foreign stock within it, but because of it.

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