Small investors often are portrayed as the “dumb money.”
It has been said that in markets they are doomed to buy just before a crash. For example, many were fatally lured into buying fashionable securities, such as uranium mining companies in the 1950s, the conglomerates in the l960s, the high-tech firms in the late 1990s, or shares in Latin American companies prior to their many currency devaluations.
A recently released study by the European School of Management and Technology reported how supposedly sophisticated money managers allocated funds. They customarily have taken advice from private banks, institutions like pension funds, or from investment consultants who have marketed themselves as unbiased investors with experience and a proven (?) record of expertise.
Managers of hedge funds are among the most qualified investors. Inasmuch as they buy and sell equities, they earn profits on those transactions by doing so correctly. However, their selection process is extremely complex, encompassing many things that are difficult to follow, such as derivatives. Their historical record has not been marked by great success and, therefore, may not be a meaningful clue to future performance.
If one can make an overall comment, it has become obvious that the primary mistake is that investors of all kinds make their decisions based on past performance. Managers who turned in the good records in the previous three quarters, attracted the best following in anticipation of continued short-term gains. Yet, shares or industry groups too frequently are in fashion in one era and fail dismally later.
What explains these selection failures?
Styles often are opaque and have only a brief “shelf life.” Those who rely on recent returns frequently have become careless, thinking again that “the past is a prologue to the future,” thus failing to do the necessary spade work.
Then too, some of this faulty decision-making may reflect an underlying approach to investments, buying on rumours or because of a whispered tip from a presumed expert.
Unfortunately, the so-called dumb investors many times are trapped by the momentum theory, that they can catch a good investment if it were moving up on large volume. At various times, the flood of new money seeking a return compels managers to act quickly so that the client can see some activity.
Clearly, various theories have been put forth from time to time, but what is key is the economic background. If the economy really is buoyant, that “rising tide” will lift many investments.
Nowadays, the opposite is the case, so extraordinary care is essential in making any investment at this time.