There are many investing trailblazers that you can look to for examples and advice, people who have performed their own research and due diligence in order to build an excellent portfolio. Warren buffet of Brookshire Hathaway is a prime and famous example. What many new (and not so new) investors have been known to do is simply mimic or copy the portfolios of these investing geniuses but, from what we have seen, this is not actually be a very good idea.
With that in mind we put together a number of reasons why copycat investing is, in our opinion, a bit dangerous and why this approach to investing is frowned upon by most experts. The reason we put this blog together is because we love our readers and also because, as we’ve said many times in the past, educating yourself as much as possible is important to your success as an investor. Enjoy.
The inability to diversify your holdings effectively.
It is common for major institutional investors to own more than 100 stocks in a given portfolio and even Warren Buffett’s investment vehicle, Berkshire Hathaway, owns shares in many different public companies even though they have a tendency to invest in fewer stocks instead of more stocks.
The one thing that these institutional investors have going for them is that they can spread the risk over several companies so that, if one of those companies, industries, sectors or even a specific country takes a bad hit, their other holdings will (in most cases) make up for them.
The problem with copycatting this type of investment strategy is that very few individual investors have the funds, or the financial acumen, to be able to achieve this type of diversification. What this forces them to do is copy a small portion of the bigger institutions holdings while sometimes ignoring others entirely, greatly increasing their risk if the holding that they invest in takes a dive.
Inability to invest for the long term.
While there are certainly plenty of people who refer to themselves as “long-term investors” the fact is that, at the end of the day, the average investor really wants to see results in the first 1 to 2 years after they have purchased a particular stock. The difference here is that larger institutions have the financial ability to be much more patient than an individual investor.
The reason that copycatting the type of diversification that larger institutions achieve is that a smaller investor, and most cases, just can’t afford to hold onto their investments as long and in many cases they simply don’t have the patience. Things like purchasing a home, medical emergencies, paying for college and other financial necessities can have an adverse effect on their portfolio and its performance.
Education, knowledge and research.
The average large institution, even though regulations such as Reg FD have been put into place by the federal government to “level the playing field” literally have teams of trained experts and seasoned analysts, along with a huge amount of contacts, to help them in their decision-making process. They also can use those contacts to keep in contact with the management team of any company that they are considering investing in, something that an individual investor simply cannot do.
One of the reasons that many individuals find that their mutual funds (for example) under perform over time is simply that they lack the knowledge about future earnings potential, competitive forces, opportunities for growth. A larger institution will have keen insight about these things due to the work of their employees and analysts.
Pair that with the fact that most individual investors can’t sit around and wait for new information but actually need to attend to things like work, children and so forth and you can see why the individual investor can easily be left out of the loop when it comes to getting the information they need on whether to stay in or get out of an investment as well as when the best time would be to purchase a new investment.
Guessing is not an option.
Let’s say, for the sake of example, that an individual investor has the money to diversify, the willingness to hold onto their investments for an extended period of time and also the ability to track and do research on multiple companies. You would think that this would make it easy to copy the actions of larger institutions but, in reality, it actually is still very difficult.
The reason is that many mutual funds, unlike Berkshire Hathaway, buy and sell stocks vigorously throughout any given quarter and anyone looking to copy their portfolio is simply left to guess on what their next move should be, a strategy that is extremely risky.
The cost of trading is expensive.
Institutions like mutual funds, by definition, have much more money to invest than the average individual investor. Retail brokers who service these mutual funds, in general, trip over themselves to help them because of the fact that they spend so much money and conduct so many trades throughout any given year.
It’s for this reason that, in some cases, you’ll find that a mutual fund may be charged a penny (or even a fraction of a penny) per share to sell or purchase a stock while an individual investor might actually have to pay between 5 and 10 cents for the same share. An individual investor, no matter their wealth or the amount of trades they are making, will more than likely never receive this kind of preferential treatment and thus never receive the kinds of returns either.
While copying a successful person or company is an intelligent thing to do and many types of situations and industries, copycatting the investment style and the profile of a successful institution like a mutual fund is much harder and, in some cases, practically impossible. Simply put, the resources, workforce, opportunities and sheer financial strength is something that an individual investor will not be able to match. It’s for this reason that individual investors should seek an investment strategy that’s better suited to the amount of time, research and finances that they are able to put in.
If you have questions about investing, strategies, building or diversifying your portfolio or financial questions in general, please let us know and we’ll get back to you with answers, advice and information.