Advanced Investing

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I have a few investments that I’ve inherited, and I plan to invest more when I graduate and get a job. I know that individual investors are generally advised to just stick to simple stuff and invest safely, but I also know that there are some famous investors – like Warren Buffett, for instance – who managed to make incredible fortunes in the stock market. What do those investors do that we, as individuals, can’t (or shouldn’t)? Or is there something I can learn from these big investors?

There are things we can all learn from successful investors, but there are also, truth be told, some things that individual investors can’t do – or, at least, can’t do anymore.

Your letter suggests that you already know that studies show most professional investors fail to beat the market when investing in individual stocks (as opposed to index funds, which aim to broadly represent the market and mirror its gains and losses, rather than beat them) and fail to properly time the market (that is, get out before big crashes and buy back in on the cheap). If such things are too tricky for the pros to do, it’s unlikely that most of us will be more successful when fiddling with our 401(k)s periodically. But that doesn’t explain superstar investors like Buffett.

But it’s also worth remembering that Buffett began as a disciple of an investing philosophy based largely on the price of a stock relative to the company’s earnings (called the P/E ratio for short). Buffett and his own idol, Benjamin Graham, poured over books and did math to find undervalued companies.

The method still works, but it’s not quite as foolproof as it once was: thanks to computers, it’s easy for lots of people to see a company’s P/E, meaning its harder to find undervalued companies. The inefficiencies may still be there, but they’re tougher to spot – especially if you’re on your own.

Still, P/E was not the first investing strategy breakthrough, and it won’t be the last. Some professional investors do sometimes manage to beat the market. Some use techniques like the RSI trading strategy to identify downturns, and – sometimes, at least – they get it right and make big bucks. Just look at the brilliant investors who pulled off “the big short,” shorting the market just before the biggest crash since the Great Depression!

But, again, this is stuff that is largely handled with computer and algorithms today. Unearthing investment revelations using just your eyes and publicly available data is pretty tough, because there’s a good chance that you’re not going to be the only one to spot companies that look good or bad – and then the price of those stocks will adjust based on buying and selling patterns, rending your insight useless.

Finally, it’s worth noting that big-time investors can gain new powers that smaller investors can’t. Warren Buffett’s company, Berkshire Hathaway, takes controlling interest in companies – meaning he can change how they’re run, hoping to improve their value. Big investors can also change the value of stocks by buying or selling them in large numbers – or merely by saying something about them in an interview! As an individual, you don’t have this kind of power, and the only way to get it is to become a wildly successful professional investor.

That’s not to say we can’t learn anything from big investors. Warren Buffett’s strategy of buying and holding stocks long-term is a healthy one for individuals, too, and shows that great profits are possible through routes other than reckless speculation. Ultimately, you’ll probably want to play it safe by investing regularly in a diverse portfolio.

“Risk comes from not knowing what you’re doing.” – Warren Buffett

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