Thursday, May 10, 2007

Reading, Researching, and ‘riting – The 3Rs of the Independent Investor.

Capital isn’t the only thing that is very affordable and abundant these days. Information is as well.

Information availability has leveled the playing field for all investors. The investment implications are significant. Take, for example, the work that I do.

While I do benefit directly from my first hand experiences as a moderator of my events, from my access to investment opinions from various sources, and the occasional interaction with fellow investment professionals at selected functions, the vast majority of my research time is spent in quiet solitude at my desktop reading, researching, and ‘riting – the 3R’s of the independent investor.

The power of the Internet has made independent research possible. As has the financial innovation of ETFs, which has enabled me to perform investment strategy analysis on a sector and style basis, something not possible previously. The construction of the all-ETF Model Growth Portfolio is the investment strategy expression of my work.

So, if information is very affordable and abundant, what's left for an investor to gain a performance advantage? There appears to be four specific ways an investor can achieve a superior rate of return: non-public information, advanced trading systems, leverage, and insight

The first two are out of reach for most investors. One is illegal. The other is the domain of specialized trading firms. That leaves the last two –leverage and insight – as the sole areas where investors can hope to gain a performance advantage.

Leverage is the path that many investment professionals are either engaged in or headed toward – whether intentional or inadvertent. As I have noted numerous times before, liquidity is being aided and abetted by leverage (see May 1 blog entry for most recent comment in this regard). However, with leverage comes added risk. One example of added risk was noted in last Friday’s blog "Quotable Quotes" entry (BlackRock’s founder and CEO, Larry Fink – “…probably the greatest issue that’s confronting the world’s investors is we are trading liquidity for illiquidity.") And leverage is a major function of that trade.

As for insight, it is the only pure and unique element of investing. Everyone tries but few succeed at being insightful. However, it is important to note that insight is not the domain of the smart, nor the well connected. In fact, it could be argued that the further away one is from the mainstream thought process, the better the chances of operating in an environment that insight can flourish*.

Investment Strategy Implications

As the equity markets continue to set new highs and threaten to overheat, some professional investors might take solace in the fact that the individual investor, the so called little guy, has yet to join the party in earnest. Last week’s large jump in individual investor bearishness is one example. However, when information is both very affordable and abundant, I wonder just how uninformed that little guy actually is.

Investors live in an age of empowerment. The playing field has been leveled, at least in the legal areas. And insight is the greatest tool of the independent investor.

*Warren Buffet being the most prominent example, at least from a geographical perspective.

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