Do Small Investors Stand a Chance Anymore?
Now that the pros buy and sell stocks within seconds, you can't rely on the old buy-and-hold idea
Although the stock market has had a good run in early 2012, stocks took investors on quite a wild ride last year. In 2011, the Dow Jones Industrial Average sank or soared by more than 300 points on seven different days — and plunged by 634 points one day in August. Yet the overall market was dead flat for the full year. So if you were a traditional buy-and-hold small investor in 2011, you probably wound up where you started.
Meanwhile, big hedge funds and major traders were making big money through computerized “flash” trades lasting only a few seconds and high-frequency trading that moves shares constantly. A former economist for Chase Manhattan estimates that the average time professional investors now hold their shares is a mere 22 seconds.
All of this may leave you wondering: Do I even have a chance anymore as an investor?
Probably not if you’re trading individual stocks, experts say. And even if you own a diversified mix of mutual funds, you may need to look beyond stocks to grow your retirement nest egg these days.
“I’m a professional and I still don’t have a chance against high-frequency traders,” says Erin Botsford, a financial adviser in Frisco, Texas, and author of The Big Retirement Risk: Running Out of Money Before You Run Out of Time. “I’m a real cynic when it comes to Wall Street. It’s almost like things are being manipulated beyond our control.”
The rules for small investors have changed because the investing world has changed.
“It used to be, buy some mutual funds, then sit back and enjoy them. But those days are over,” says Robert Laura, author of Naked Retirement and co-founder of The Retirement Project, a retirement and investment education program.
When you invest for retirement, start by estimating your retirement income and needs, then create an appropriate investment plan. Don’t focus on matching or beating the stock market, says Liz Weston, author of The 10 Commandments of Money and blogger at AskLizWeston.com. Instead, create a diversified portfolio of stocks, bonds and mutual funds that will help you reach your goals.
“Retirement should stop being a D-I-Y project when you’re within 10 years of retirement," Weston adds. "And most people would benefit from a session with a fee-only planner even before that."
You should also give up the traditional small-investing idea of buying stocks or mutual funds for the long term then forgetting about them. Some people buy target-date mutual funds or invest in target-fund accounts in their 401(k)s as a set-it-and-forget-it strategy. With these investments, you pick the year you plan to retire and the manager buys and sells stocks and bonds between now and then, making the portfolio increasingly conservative as your retirement date nears.
Today it's essential to adopt a more proactive approach to investing, says David Aquilina, senior vice president of investments at Leonard & Company, a brokerage firm based in Troy, Mich. That means selling your investments to take gains or losses quickly, rather than letting them ride.
“I think the buy-and-hold strategy is done,” Aquilina says. “I’m seeing the need for a whole new mindset where, when somebody’s got a gain, they want to lock it in.”
Aquilina recommends setting what are called stop-limit stock orders to limit your losses and capture your gains. With a stop-limit order, a broker automatically sells your shares if they drop to a certain price — or rise to a particular price — that you’ve specified in advance.
You may also want to consider diversifying to protect yourself against sharp market swings.
One way to do this on your own is by buying dividend-producing stocks that reinvest their dividends into new shares automatically. More than 1,000 companies offer direct investment plans (called DRIPs for short, and formerly known as dividend reinvestment plans) that let you buy their dividend-paying stocks without going through a broker.
Annuities from insurance companies are another possibility, because of their guaranteed returns. Fixed annuities can function almost like a bank certificate of deposit. Some variable annuities offer the option of a guaranteed "living benefit," that delivers a set monthly payment for life.
Botsford also recommends alternative investments that emphasize cash payouts, rather than betting on price appreciation from stocks. In addition to annuities, she suggests considering real estate investment trusts (companies that own apartments, shopping centers and other properties) and limited partnerships. You'll want to work with a trusted adviser who can help choose appropriate investments that won't come with exceessive fees.
