Where Main Street Beats Wall Street

Includes: LQD, XLF
by: The Conservative Income Investor

One aspect of investing that I suspect many take for granted is this: the professionals are better than the average joe investors. It certainly holds true in many other areas of life—if a guy looks at a chart for awhile, he probably won't be able to fill in a cavity better than a dentist. Reading a couple medical journals won't make someone better at heart surgery than a doctor. And it's easy to assume that automatically extends to investing as well: anyone who works on Wall Street must automatically have an advantage over the lay Main Street investor.

While this might seem intuitively true, there is an argument that suggests Main Street investors have a very important advantage over their Wall Street counterparts. As the famed economist John Maynard Keynes explained this in his famous treatise The General Theory of Employment, Interest, and Money:

"It might have been supposed that competition between expert professionals, possessing judgment and knowledge beyond that of the average private investor, would correct the vagaries of the ignorant individual left to himself. It happens, however, that the energies and skills of the professional investor and speculator are mainly occupied elsewhere. For most of these persons are, in fact, largely concerned, not with making superior long-term forecasts of the probable yield on an investment over its whole life, but with foreseeing changes in the conventional bias of valuation a short time ahead of the general public. This battle of wits to anticipate the basis of conventional valuation a few months hence, rather than the prospective yield of an investment over a long term of years, does not even require gulls amongst the public to feed the maws of the professional; it can be played by professionals amongst themselves."

The somewhat counter-intuitive logic that Keynes employs in the paragraph above highlights the one critical advantage that Main Street investors have over Wall Street: the ability to invest long term. When you're running a mutual fund, you are under pressure to not only predict the future correctly, but you must also predict when the event will take place. If you have a couple of low-performing years, your career is over. Just ask Bill Miller how forgiving the investing world is.

But the Main Street investor has no such short-term deadline. It's only necessary to predict what will happen, but there is no penalty for taking too long to predict when it will happen, other than the fact that the longer it takes an investment thesis to come to fruition, the lower the annualized return. If you think Bank of America (NYSE:BAC) is due to restore its dividend to a meaningful amount that will send the price of the stock higher, you can still do quite well if the event happens in 2014 instead of 2013. But the Wall Street professional faces the pressure of not only predicting this event, but timing it perfectly as well.

This is an advantage I have no desire to squander. If the market is misjudging the value of Becton Dickinson (NYSE:BDX) by overestimating the long-term impact of currency fluctuations on the firm's bottom line, I can sit back and collect the dividends growing at 7-10% per year while waiting for the market to give Becton Dickinson a fair value. If I think Aflac (NYSE:AFL) is in the process of rising to $75 per share while the firm removes the toxic investments from its portfolio, I can pick up a dividend that is growing at 8-11% per year while I wait for Aflac to improve its earnings quality and get the market to reflect that. If it takes until 2015 or 2016, so be it. I'll most likely enjoy a growing dividend while I wait. How many Wall Street money managers can wait until 2015 or 2016 for an investment to pan out?

You don't have to go too far to find people who claim "Wall Street is rigged" or "Investing is nothing but a wild casino." That's true in the short term. Not only can I not predict what Johnson & Johnson (NYSE:JNJ) will be priced at next week, but I'm setting myself up to lose if I'm competing with rapidfire computer traders that essentially front run stock prices and blow by me. That's not the game I want to play. I'm much more content spending my time determining whether Procter & Gamble (NYSE:PG) will right its ship, and then waiting until 2017 or 2018 to see how my investment thesis played out. Most professional managers aren't in a position to do that.

Wall Street is playing a short-term game. The nature of success on the New York investment landscape follows the "What have you done for me lately?" paradigm. When Warren Buffett started buying stock in Coca-Cola (NYSE:KO) in the late 1980s, the prevailing response among the Wall Street crowd was this: "Coke has run up way too much lately. It's bound to cool off for a year or two." Instead, Buffett felt Coca-Cola was set to achieve significant international growth in the coming decades, and thus began his legendary billion-dollar bet. That is the type of insight that is within the skill set of the Main Street investor to formulate and execute. That's why you won't see me joining the chorus that chants "long-term investing is dead." It's the biggest advantage Main Street investors have.

Disclosure: I am long BAC, BDX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.