Why Amateurs Should Invest in Common Stocks

There is a benefit to investing directly in common stocks as an individual.  I’ll let Buffett help me explain this:

“I am a better investor because I am a businessman and I am a better businessman because I am an investor.”

My own life is one of having been an amateur investor, and became a professional investor over time.  My mother is an excellent amateur investor, one whose record would put 90%+ of professionals to shame.  I know some great amateur investors, but they are not the norm.  If they were the norm, we would not have lots of financial intermediaries trolling for business.

After yesterday’s piece, I want to say that though most amateur investors do not beat index funds, there is still one big reason to buy individual common stocks: it can make you a better businessman.

As an example, I had  never worked in a marketing department in my life, but because of my investing, and study of marketing on the side, I was able to lead a revamp of a marketing department, leading to a threefold increase in sales in five years.  Return on equity went from 10% to 50%, aided by the booming stock market of the ’90s, but that was only a help.

Technical specialists have to ask, “Do I want to remain a technical specialist, assuming that I have that option, or do I want to broaden my skill set and learn the economics of the business that I serve?”  Those that invest in stocks, and study them carefully learn practical economics.  You may earn money or you may not.  You may beat the market or you may not.  But you will become a more valuable employee, because you will grasp more and more about what makes your company tick economically.

I can tell you that while I was in insurance, the brightest move I made was investing in stocks privately, and studying equity and bond investment intensively.  It made me more valuable to my bosses, and helped me understand my own company better.  It made me better in interviews as well.  Questions that were designed to see if I could think beyond my narrow specialty became easier for me.

Now, some of the successes came with failures.  For a while, I told my kids never to mention the name “Caldor” to me.  Yeh, Michael Price may have lost a billion on that one, but I more than took my licks.  Until you lose a decent amount, you don’t really understand how the market works.  You can call it market tuition, but like tuition at college, you don’t know how much value you will get out of what you have paid.

I encourage new investors to paper-trade.  I did that when I was young.  It allows you to experiment and learn about what you think works in the market, without consequences.  I think it helps ease the transition into investing.  When you start investing, your emotions will be a lot higher, but it helps a lot to have a guiding theory going into it, it helps control the emotions that will come.  It took me 5-10 years to discipline my emotions, and think about markets rationally, not emotionally.

So, there are benefits to investing in individual common stocks, but they may not be the ones you expected.  It will help you understand your business better, your industry better, and perhaps even your nation and the world.

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But, this is not to say that if you act as a bettor, rather than an investor, that you will benefit.  Think of Buffett’s quote above — business and investing go together.  Inside a corporation, one of the highest levels of what is done is the investing.  Buffett looks for businesses that will throw off gross profits well in excess of financing costs — that is different than most investors think, because Buffett is a businessman.

For budding businessmen, you could ask where business value is growing the most rapidly relative to the price that you pay — Earnings relative to price helps but there are sometimes aspects of businesses where growth in value does not reflect in the earnings statement.

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And, all of this is not to say that professionals do better than amateurs.  Professionals don’t do well, and they add on fees.

There is one area where professionals seem to do better, but I could be wrong.  If I am wrong, could someone send me some research?  As I pointed out yesterday, amateur investors tend to become greedy and fearful at the wrong times.  Professionals seem to be less prone to this problem, perhaps because of discipline.

As Baruch commented at my blog:

I think it is also something you can learn, because so much of investing skill is not innate, in my opinion, rather it really comes from an attitude, and an act of will. Discipline comes from will. The rest comes from a basic knowledge of accounting, markets and finance which anyone with a university education is capable of grasping. A lot of people without a university education are as well.

To which I will agree — it’s not that you need a high IQ, but a lot of general learning, wisdom on accounting, markets, and finance, and common sense.  Read stuff by Charlie Munger, the man is under-rated in the shadow of Buffett, but at least he has written  a book.  Would that Buffett would do the same.  There are many that interpret him, but I would like to hear how he views investments in theory in full, so that the rest of us could benefit.  In many ways he has surpassed his teachers, Ben Graham and Phil Fisher.

So Warren, could you give us the 21st century version of “The Intelligent Investor?”  That could be an invaluable legacy that many would thank you for, as much as they do for Ben Graham today.

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Final note — if you invest in common stocks, it is likely you will underperform the major averages until you gain wisdom and discipline.

About David Merkel 144 Articles

Affiliation: Finacorp Securities

David J. Merkel, CFA, FSA — From 2003-2007, I was a leading commentator at the excellent investment website RealMoney.com (http://www.RealMoney.com). Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and now I write for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I still contribute to RealMoney, but I have scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After one year of operation, I believe I have achieved that.

In 2008, I became the Chief Economist and Director of Research of Finacorp Securities. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm.

Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life.

I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

Visit: The Aleph Blog

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