A fantastic investment weapon for private investors

I came across a great piece of investment jargon last week.

Now, that’s a pretty rare event for me. I think a lot of jargon just ends up confusing people and doesn’t help anyone.

But this latest piece of jargon highlights a crucial advantage that private investors have. And this advantage means there’s no reason why private investors can’t generate excellent market-beating returns over the long-term.

What is the jargon?

So what’s this piece of jargon I like so much?

It’s ‘time arbitrage’.

You’ve probably heard of arbitrage before. It normally refers to a situation where an asset has different prices in two different markets. So if a company is listed in Paris and New York, and the share price is slightly lower in Paris, an investor can quickly buy in Paris and sell immediately for a higher price in New York. The investor is exploiting a price difference between two markets.

Time arbitrage is a bit different. It’s exploiting a difference between the buyer and seller in a transaction – their ‘time horizons’.

Many professional investors operate on very short time horizons. In other words, they only anticipate keeping their investments for months, weeks, days – or even seconds, in some cases. So in the super-short term, you have the ‘high frequency traders’ who use computer algorithms to spot fleeting opportunities. There’s no way a private investor armed with a desktop can compete with these guys. Or at least, not if your time horizon is very short.

Your average fund manager isn’t a high frequency trader. However, most fund managers’ time horizons are too short in my view. That’s because most managers are judged on their performance every three or six months. So if a company hits short-term problems, it’s hard for your average fund manager to stay invested. Even if a manager is confident that the underlying prospects for the company are fine, the pressure to sell and cut his losses is very strong.

Use time arbitrage to your advantage

The good news is that private investors don’t have to worry about any of this. If the value of my portfolio falls over the next year, no one but me is even going to know about it. And if that happens, I’ll stay calm because I know I’m playing this game for the long-term.

So if I’m buying a share from a high-frequency trader, I’m exploiting a difference in our respective time horizons. I’m investing for the next 20 years; his horizon is seconds or minutes.

And if I buy a share from a professional fund manager, once again I’m almost certainly investing over a longer horizon than he is – regardless of the marketing bilge you’ll hear from the fund management company concerned.

As Morgan Housel writes on The Motley Fool: “There’s something every mom-and-pop investor can do to gain an edge on the person on the other side of the trade: be willing to wait longer… There are few things more powerful in investing than the realisation that the biggest gains tend to accrue to the person who waits the longest.”

So if a company says that something has gone wrong, we don’t need to panic. One recent example of this is GlaxoSmithKline (LSE: GSK). I’ve owned shares in this drugs giant for several years, so I wasn’t best pleased when the company warned last month that its new respiratory drugs weren’t doing as well as hoped. But I didn’t stay irritated for too long, because I knew that this profit warning would probably be forgotten by just about everyone in five years’ time.

Glaxo will recover, its share price will recover, and I’ll continue to receive a great dividend while I wait for that recovery. In fact, I think now is a great time to buy into Glaxo while the shares are relatively cheap.

The other big attraction of time arbitrage is that it reduces the risk of investing in the stock market. Yes, the stock market is risky and volatile. But when you look at stock market history, it’s clear that the longer-term trend is up. If you stay invested for ten years or longer, you’ll almost certainly experience some sizeable ups and downs, but overall there’s a strong chance that you’ll make a profit.

And you don’t even need to buy individual shares to benefit from this long-term growth. The simplest approach is just to invest in some low-cost index tracker funds that match the performance of a stock market index. So if the FTSE 100 index goes up by 20%, a FTSE 100 tracker fund should go up by roughly 20% too.

Even better, the charges for many index tracker funds are now extremely low. You can read about my favourite index tracker funds in my recent article: A guide to the all-new Nisa. (If you’re not a MoneyWeek subscriber, sign up for a four-week free trial and you can read the article in our web archive.)

But whether you go for individual shares or index trackers, remember that time is the investor’s best friend.

• This article is taken from our free daily investment email, Money Morning. Sign up to Money Morning here.

Our recommended articles for today

Deflation is exactly what Europe needs

Southern Europe is crying out for the money taps to be turned on. Bengt Saelensminde explains how he’s lined up to profit when the European Central Bank caves in.

This is the bellwether stock for China

If you’re planning to invest in China, you should keep an eye on this stock, says Lars Henriksson.

On this day in history

5 August 1858: the first transatlantic telegraph cable is completed

On this day in 1858, HMS Agamemnon and the USS Niagara completed the mammoth task of laying the first transatlantic telegraph cable.

  • NVP

    perhaps a little too simplistic in investments terms…..and with big pharma going through some interesting step changes in their business models …..relying on everything staying the same and returning to mean may be a little optimistic ?


  • mr clyde

    I have been applying this principle to the management of my portfolio for the last 20yrs and would entirely agree that it is the key ‘edge’ that a private investor has over the pros. However I am not sure you can apply it to trackers which, by their nature will include long-term losers as well as the long-term winners. If you had invested in a FT100 tracker in Dec 1999 your Cap Gain would still be out of the money and a decent bond fund would have provided a better ‘dividend’. Due regard to ‘return to mean’ and ‘variation in sector cycles’ amongst other considerations play an important part in my strategy.

  • jimtaylor

    Isn’t this simply a Value Investing approach towards Stock Picking in quality companies?

  • Inquisitor

    Mark Spitznagel has a similar approach to investing, which is an “Austrian” elaboration on value investing. Albeit he relies on indices to show excessive “frothiness” in markets, too.

  • mr clyde

    Yes -pretty much.


Claim 12 issues of MoneyWeek (plus much more) for just £12!

Let MoneyWeek show you how to profit, whatever the outcome of the upcoming general election.

Start your no-obligation trial today and get up to speed on:

  • The latest shifts in the economy…
  • The ongoing Brexit negotiations…
  • The new tax rules…
  • Trump’s protectionist policies…

Plus lots more.

We’ll show you what it all means for your money.

Plus, the moment you begin your trial, we’ll rush you over THREE free investment reports:

‘How to escape the most hated tax in Britain’: Inheritance tax hits many unsuspecting families. Our report tells how to pass on up to £2m of your money to your family without the taxman getting a look in.

‘How to profit from a Trump presidency’: The election of Donald Trump was a watershed moment for the US economy. This report details the sectors our analysts think will boom from Trump’s premiership, and gives specific investments you can buy to profit.

‘Best shares to watch in 2017’: Includes the transcript from our roundtable panel of investment professionals – and 12 tips they’re currently tipping. The report also analyses key assets, including property, oil and the countries whose stock markets currently offer the most value.