5 reasons why retail investors have an advantage over mutual funds!

Most retail investors think that big money such as mutual funds or hedge funds have an advantage over retailers. Mutual funds have better connections and get access to information faster than the retail investors. While this is true, there are many advantages which retail investors have but they fail to capitalize on them to produce a better return when compared to Mutual funds. 

It used to be the case in the past where the Stock Market was a monopoly being run by a few organizations with huge capital and good networking. Stocks used to be traded in physical format in the BSE ring by jobbers who had to be paid huge commissions making it difficult for common man to get involved in the Stock Market! But now, with many discount brokers who have highly simplified the process of buying and selling stocks, it is the best time to shine as a retail investor and use all their advantages to make good returns from the stock market. 

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Here are 5 reasons why retail investors have an advantage over mutual funds – 

1. Buying and selling of stocks is much easier – Did you know that mutual funds have to declare their buying and selling orders beyond a certain percentage of holding? Unlike retail investors who can easily buy or sell stocks in the open market, big funds generally have to declare their orders publicly when they are buying or selling large sums of shares (which they generally are). Another way for big funds to buy or sell a large quantity of shares is through a Block Deal. In a block deal, there needs to be two big parties (one to buy and another to sell the shares) at a predetermined price. Compare all this hassle to how retail investors can enter or exit stocks. You simply have to click or swipe buy on your investment app and you are done. Nobody needs to declare orders or do a bulk deal for a transaction as small as Rs. 4-5 Lakhs (yes this amount is small in terms of Stock Market)

2. Better returns when trading – Since buying and selling is much easier for retail traders, the returns which retail traders can make are generally higher than big funds. Let’s say that both a hedge fund and a retail trader want to trade a certain stock. Suppose the stock is currently trading at Rs. 100 and is to be traded with a stop-loss of Rs. 90 and a target of Rs. 120. 

• Suppose a hedge fund wants to buy 1 crore quantity of this stock to trade. It will be very difficult for them to get 1 crore sellers to get the stocks at the price of Rs. 100 per stock! So they will buy some shares at Rs. 100, remaining at Rs. 100.25, some at Rs. 100.50 and so on. Buying a quantity of 1 crore stocks will mean that their average buy price will be around Rs. 102 instead of Rs. 100. They will face the same problem when trying to sell their stocks at the target price of Rs. 120. 

• Suppose a retail trader wants to trade 1000 quantities of this stock. All he/she has to do is buy the share at Rs. 100 and sell the shares at the target price of Rs. 120. Since the quantity in which retail traders trade is small, it is generally far easier to find buyers and sellers for the stock at the exact entry price, target or stop loss!

Here is a table showing the returns which hedge fund and the retail trader made on the same stock.                          

It can be clearly seen that small differences made due to the quantity of shares traded made a HUGE difference in the returns of the trade. Retail traders have a clear advantage due to their small capital! If you want to learn a professional trading system, please visit the article – New trader’s guide to a professional trading system!

3. Retail investors have good knowledge about their domain – One of the biggest concerns which retail investors have is the fact that big funds have a great research team whose goal is to find good companies to invest in. While this is true, retail investors have a great source of information which they often ignore – their workplace! Most retail investors either work a job or have a business apart from the stock market. They have key insight about the internal working of a company, know about a key product being launched and even how the roadmap which the company management has for the future growth of the company. If you work in a car manufacturing company, you will know if the sector is doing well or not & whether the next few years look good for automobile manufacturers! If you work in an IT company, you will know the same things about your company and sector. This is key internal information which only the management and employees have access to, not big funds!

4. Big funds are tracked by everyone– One problem which big funds face is that their portfolio is continuously tracked by people. Most people and news reporters focus a lot on the buying and selling which is done by big funds. This removes any chances of anonymity of the portfolio and brings the entire portfolio right in from the world along with the exact proportion of holding. If a big investor decides to sell a major chunk of his/her holdings, they will be asked a lot of questions by the media for their decision making. On the other hand when a retail investor decides to buy or sell a stock, nobody cares! Which is a good thing in this case because anonymity in the Stock Market is very important. But you might be thinking – Why is anonymity important in the Stock Market? If some hedge funds know that a pension fund has heavily invested in a company, they may start to gang up and short the company to a point where pension funds are forced to sell their stocks at a discount thereby making huge losses. Therefore, it is much better to keep your stock holdings private which is much easier for retail investors. 

5. No restrictions on retail investors – Mutual funds always have a restriction on them due to the simple fact that it is a “mutual” fund. This means that it is mutually being owned by multiple parties. So if there is a mutual fund which only invests in large cap companies, then they cannot invest in any small or mid cap company regardless of how well they are doing. If there is a mutual fund which can only invest 1:1 in stocks and bonds, then again they are restricted. Mutual funds cannot buy more stocks than bonds or vice versa depending on the conditions of the Stock Market. This is a huge advantage for retail investors who do not have any restrictions over them. It is perfectly okay for a retail investor to invest in a micro-cap company (companies with size even smaller than small-cap companies). Mutual funds can never even dream of investing in micro-cap companies because they are bound by the rules on which types of companies they are allowed to invest in. However, just because retail investors can invest in micro-cap companies doesn’t mean that they should! To find out how to find good companies to invest in the stock market, please visit the article – How to choose your first Stock?

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DISCLAIMER : I am not a financial advisor. I am not for or against any company which I have mentioned in this article. All the information provided here is for education purposes. Please consult a financial advisor before investing.