By: Dividend Sensei
Everything in finance is a trade off, a risk/reward calculation. What gives small investors an edge over Wall Street is time arbitrage.
Under general market conditions, big money is concerned with short-term profits, so for example, utilizes high frequency trading via algorithms.
This is why avoiding day trading is important. You can’t beat the big boys at a game they’ve invested billions into perfecting. That isn’t your edge.
Your edge comes from the fact that, in a market crash, institutional money, such as mutual funds, get inundated with withdrawal demands, and thus must sell, even blue chip DGI stocks, at fire sale prices, even when the money managers know this is a buying opportunity.
Hedge funds, thanks to their large leverage, are in a similar scenario. Margin calls mean they need to sell assets to raise capital quickly, and can’t afford to be too selective in what they sell.
Volume on the sell side soars, on the buy side, a lot less demand. Illiquidity results in prices collapsing, AND this is where the retail investor has the edge over Wall Street.
Your long-term strategy lets you become the smart money, and take advantage of the panic, and desperation of the big boys. You take the other side of the crash, buying at rock bottom prices.
Remember the flash crash? Imagine being able to buy blue chip DG stocks like KO, PG, and MMM, at a 10%, 20%, even 30% discount for a few minutes.
This is why behavioral finance is the most important thing to study to beat the street. Know thyself, your personality profile, set up your portfolio to survive the next crash, THEN prepare to profit from it.
Index investing, buy, hold, reinvest the dividends, will get you around 9% a year, the market’s historical return, over time.
Do this, and this alone, if you don’t have the passion, interest, or time to learn about individual company tracking, and you’ll become a good investor, beating most people who panic and sell at the bottom.
BUT if you want to become a great investor, well that, my friend, is where individual stocks, and true courage are what separate the merely good from the truly great.
S&P 500 is just the biggest 500 companies in America. Not all of them are dividend stocks, (most successful kind of asset in history) and certainly not all are high quality and worth owning.
In fact market studies show that 40% of the S&P 500 companies are responsible for 100% of the gains, with 60% of the S&P 500 being trash that you should try to avoid.
Individual stock selection is the chance to build a portfolio of just those top 40%, the quality, dividend growth stocks.
Look at the dividend aristocrats vs S&P 500 over time. DA index beats the regular index because its higher quality companies, and the dividend reinvestment creates stronger compounding effects.
Most people think of “beating Wall Street” as stock picking, finding the next GOOG, NFLX, AMZN, AAPL, or FB.
This is only partially true. If you merely stick with high quality DGI stocks, a core blue chip portfolio (dividend champions) plus some faster growing dividend achievers, and contenders, then you’ll have the higher quality, faster growth potential, and under yield + dividend growth, should beat the market over time.
BUT the thing that can turn you into a legend is the “be greedy when others are fearful” component, catching falling knives in a crash.
It takes an iron stomach, and supreme discipline, (plus cash reserves and sufficient discretionary income) to take advantage of a correction, bear market, or outright market crash.
BUT if you combined quality DGI, plus superior capital allocation, ie buying on dips, and crashes, (to lower cost basis and raise YOIC), AND hold for long enough, well my friends, then beating the market is all but certain, especially if you have a diversified portfolio.
So as you can see, beating the market and getting rich is easy, at least in theory. The reason everyone doesn’t do this is two fold.
1. Big money on Wall Street can’t afford to do this approach. You can’t charge high fees, or hedge fund 2 and 20, for mostly sitting on your but and not doing anything 99% of the time.
2. Psychology studies show that losing money hurts twice as much as making money so loss aversion means that most people, especially those who don’t know market history or about the academic studies that underpin long-term buy and hold DGI value investing, won’t be able to maintain discipline during a crash. They will panic, sell at the bottom, and we, the DGI faithful, will be there to take the opposite side of that stupid trade.
Which is why, in the short-term, Wall Street is the house, BUT in the long-term buy and hold DGI investors are the house, and as the saying goes, in the long-term the house always wins.