Financial Opinion and Insights

Can Small Investors Compete?

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

You’ve seen the cable tv investment gurus and you’ve read all the stock market newsletters – you’ve even attended one of those trading system seminars at a downtown hotel.  You’re convinced the small investor can `beat the market’.  Trouble is, studies show that for the vast majority of small investors it’s seldom the case.

Now, admittedly, what I’m about to tell you is only my opinion.  But, after 19 years in this business, I feel qualified enough to go ahead a blurt it out.

Yes, I think the small investor can compete; but, probably not the way you constantly see, hear, or read.  As usual, some financial education is in order:

Diversification:    Warren Buffett once said, “Diversification is protection against ignorance”.   What he was saying was, I think, quite correct!   The more you diversify, the more you’re merely creating, or replicating, an index of a broader market.  So, you’re not diversifying away market risk or giving yourself a chance at outperforming an index.   I’ve written about the ‘benchmark myth’ before. 

So, if concentrated portfolios would seem to have the best chance at achieving outperformance, does that mean we buy only ten high-fliers and hope for the best?  I don’t think so.  This is where asset allocation comes in.


The fact is the broad-based indexes like the S&P 500, comprised of the 500 largest companies, generally contain the widely-followed companies and all the analysts and professional managers on Wall Street all have access to the same public information (trading on inside information is a felony and, trust me, all those people who tell you they have ‘inside information’, don’t).

It’s virtually impossible, in my opinion, to outperform the pros in an area that’s so widely followed.  If you’ve ever read Warren Buffett’s annual reports or books about his early investing, his early highly concentrated positions tended to be in companies that weren’t widely followed, i.e., the `small cap’ and `emerging’ companies.

But, Warren went to Columbia and studied under Benjamin Graham.  Most of us didn’t go to Columbia, Yale, Harvard, or Wharton or many other notable institutions.   That being the case, how can you get an edge?  How can you compete?

You may not be able to – or even want to –  invest in those markets on your own; but, there are professionals who specialize in companies and markets that aren’t so widely followed.  For the small investor, those are the areas where you have the best chance, I believe, to add some performance; but, you want to be prudent and responsible with your approach.

Here’s an easy-math hypothetical example:  Let’s assume that 90% of a portfolio is invested in a well-balanced portfolio of quality large company stocks along with a well diversified assortment of quality short to medium term investment-grade corporate and government bonds, as well as some cash.  Let’s further assume that 10% is invested with managers managing small and emerging market companies.  Those companies generally tend to be more volatile in their price movements.

Even if your well-diversified 90% does nothing at all, a 20% move on 10% of assets will affect overall performance by 2%  (20% x 10%).   Obviously, your moves can go either way, plus or minus, and you can move more or less than my example; but, the point is that a major move in either direction will affect overall portfolio performance by a lesser amount due to the smaller allocation.  Why is this good?  Because you can create a highly concentrated approach with a small portion of assets with the goal of adding 2% a year to performance of your overall portfolio!

And,2% a year can add-up to a LOT of money!  On $100,000, a 7% return over a ten-year period instead of a 5% return means an extra $33,826!   A 9% return instead of 7% over the same period would mean an extra $40,021, and on $500,000 the difference would be over $200,000… on only 10% of assets!

Okay, so much for hypothetical examples.  Should YOU invest a portion of assets in concentrated portfolios of not-so-widely followed companies?   If so, how much?  That depends on your age, time-frame, the level of your assets and the future obligations you face, including tax and estate issues.  In short, you should talk to your advisor about creating a professional plan with an investment discipline.

You may want to request a report I have available: Why Investors Fail.  You can use the ‘Request Info’ button on our website.

And, of course, feel free to call me at 800.257.6659 or 805.265.5416, Ext. 1 if I can be of help.


The Independent Financial Group is a fee-only registered investment advisor and does not sell products earn commissions, or accept any third-party compensation or incentives of any description.  IFG also does not provide tax or legal advice.  The reader should seek competent counsel to address those issues. Opinions expressed in this piece are those of the author.