The retail investor, or individual investor if you prefer, is the punching bag of every Wall Street discussion. Well, not every discussion. Sometimes it’s the expensive hedge funds getting beat by the broader market or cash-burning tech companies with huge market caps, but suffice it to say the retail investor is always a safe target for scorn. The data is in, market watchers have reviewed it, and they no longer care about Retail Ralph’s feelings when they tell him just where things stand.

Retail investors underperform, dramatically and with consistency. Entire trading strategies have grown up around this one simple truth. Check out the “odd-lot theory” and how savvy investors  implement it. The bottom line is this: find out what Retail Ralph is doing and take the other side. What’s the P/E ratio? Earnings growth rate? ROE? ROA? Debt to equity? Who cares? What’s that guy doing because I want to take the other side.   

I hope Retail Ralph has thick skin. I for one have begun to feel sorry for him and maybe it’s wishful thinking, but I’m beginning to think his luck may turn. Maybe next year Retail Ralph will move in and out of investments with vision and precision and outperform the market. Retail Ralph could become Alpha Ralph!      

To consider how likely this is we have to first concede that Retail Ralph has scuffled. We have to be clear-eyed about things and our analysis must begin with some honest-to-goodness truth telling. The chart of twenty-year returns I’ve included above is proof enough that I mean business about being honest here.   

It’s hard to look at that chart and not hold your nose. How bad has it been? Unable to keep pace with inflation bad. It’s hard to believe millions of people trying so hard over decades could do so poorly. Seriously, how could investors actually earn less than inflation over a twenty-year period in which the S&P 500 earned 8.2% per year? If all retail investors were required to keep their money invested with instructions to seek underperformance, would they outperform the broader market by the same huge margin? Why not?

But why are retail investors so bad? What is wrong with Retail Ralph? Well, thankfully we have a trove of evidence that altogether displays a collection of pathologies. Let’s quickly look at three big ones. 

  1. The economy feels weaker, sentiment is down, the market is low and Ralph does what? He sells. Sometimes he thinks of holding out, buy my goodness, his $320,000 has turned into $175,000 and he is getting out of this rat trap stock market. 

    I think in Wall Street jargon this is referred to as selling low. 

  2. The investment of the moment is hitting big. It sounds promising and Ralph has two neighbors who are making big money. I mean big money. Check his driveway! Prices have gone way up and Ralph does what? He buys. 

    I’m pretty sure this is selling low’s evil twin, buying high. 

  3. Ralph and almost every other individual investor dreams of the big winner. But ironically, they almost never, never, ever hang on to the investments which turn into truly big winners. The average guy who does so much as dabble in the market is confident he would know how to handle a killer trade. He looks back and thinks if I had gotten in on Walmart early, and gotten up, I would have held. I know how to “play with the house’s money,” Vegas last weekend notwithstanding. Walmart went public in October of 1970 with an IPO price of $16.50. It’s since split 11 times and went up a bunch. In fact, $5,000 invested in October of 1970 is worth about $74 million today. The dividend alone would pay you about $1.3 million a year. I took a break from writing this to call my dad Jeff to ask why he didn’t scrap that $5,000 together back in 1970. He reports he did not have $5,000 in the 70s. I presume that’s the best answer. 

Back to Ralph, what are the chances Ralph held on, riding the investment in this big winner from $5,000 to $74 million? About zero. And if you can’t win when you actually purchased the winning ticket, you are in the wrong game, which is why picking stocks is the wrong game for just about everyone.

The graduate economics student down the street tells me it’s pretty much a fact, individual investors always cash in the big winners early, before they really win big.   

So, if Ralph and his buddies can’t pick stocks or effectively time the market, and the mattress method doesn’t work, what should they do with their money? A few spectacular human specimens aside, there is really only one way that works.

An investor needs just three things. He must have:

  1. a strong asset allocation
  2. a strong investment process, and
  3. a really strong commitment to both 1 and 2

I’ll devote future efforts to the intricacies and nuances of asset allocation, but I’ll say this as a placeholder. If you fail to spread your bets and invest all your money in stocks, even a big basket of stocks, get ready for the ride. When living, breathing human beings with real bills to pay see their net worth drop 35% or even 55%, they start feeling sick. Second guessing, regret and worry raise their ugly heads and they make for poor fellow travelers in life. When most people get down 35% or more, these fellow travelers are right there with them. In the car. In the bed. At work. Most people are ready to kill these fellow travelers off, selling out of their underwater investments and offering a eulogy about rat trap markets and how they just aren’t built for investing. And folks, stocks are hands down the best investment out there over medium- and long-term timeframes.

So, you need an asset allocation strategy that spreads your bets to minimize downside risk, but you also need a strong investment process. One really solid approach is to invest additional funds each and every year, and to rebalance your investments annually in order to maintain your strategic asset allocation. In the absence of this kind of process, you are left’s with Ralph’s process which features goodies like buying high and taking small profits on big winners. Actually, on second thought, I’m glad Dad didn’t put $5,000 in Walmart only to sell out at $6,000, or even $30,000. That would be tough to swallow. 

 The third principle about commitment simply points back to the first two. This principle is important because it tells you what to do when the world goes crazy. Stick with it. Ride it out. A well-designed strategic asset allocation managed well over time creates real wealth. 

Going forward, perhaps things will be different for Retail Ralph. Next year everything could change. Ralph could light the wick and start killing it with big returns. In fact, yes, I feel it. Next year, everything will be different. While we are it, give me Wofford over Clemson for $1000. Call your bookie now!