Cramer's Case for the Individual Investor

There's a certain segment of the punditocracy that believes it's wrong for individuals to manage their own portfolios of individual stocks and downright irresponsible to encourage people to do so. These people, content in the knowledge of their intellectual superiority, think that everyone should be invested in index funds because "it's impossible to beat the market."

Obviously we at Mad Money think that's hogwash. And if you followed that advice, you got treated like hog – you were slaughtered. It's bizarre. Two big ideas gained widespread acceptance during the greatest bull market in history (the one that recently ended):

1. EVERYONE should be invested in stocks, and
2. NO ONE should invest on their own.

In the last year and a half, both notions have been discredited. But while people recognize the failure of the first idea, no one seems to be pointing out the failure of the second. Since most of the people who criticize Mad Money buy into the argument that everybody should own index funds, it's my job to demolish their implicit argument. (By the way, think of how terrible a market would be where everyone was invested in index funds? It wouldn't work. A stock market full of free riders is a really crummy stock market)

Don't get me wrong, index funds are great. They're a valuable and welcome innovation for investors. Everyone should be aware of them, and there are lots of times when they may be the best choice for someone who wants some exposure to equities.

However, there seems to be a near consensus among the punditocracy that index funds are the only appropriate equity investing choice for the vast majority of nonprofessionals. Therefore, anyone who in any way encourages people to try to do it themselves is downright criminal.

Why has this transparently bogus consensus emerged? I think there are two reasons. First, most people who pontificate about stocks and investing don't really know much about those things. There's no reason they should. Usually they've never done it themselves. Most are casual observers, and in most cases they don't claim to have any expertise. Just good old American common sense. How difficult can it be anyway? Everyone knows about stocks. That's exactly the argument that annihilated the portfolios of all the people who believed timing the market was impossible. Individual investors picking stocks on their own, on the other hand, could have saved themselves fortunes by getting out when Cramer said sell at Dow 11,300 back in September and Dow 10,000 on his Oct. 6 Today show appearance.

Second, index funds do have a serious argument in their favor. The random walk argument. In essence, the case for index funds is that it's very difficult, perhaps impossible, to beat the market. So why even try? That's a good argument. It started out as the case against professional managers, rather than amateurs. Most actively managed mutual funds don't consistently beat the market. Therefore, if you're turning your money over to someone else to run for you, why not put it into an index fund and pay a significantly lower fee?

I totally agree with that case for index funds. Actively managed funds, as a class, are the worst type of investing. That's because there's an inherently misleading aspect to the way nearly every one of these funds operates. Most people assume that a mutual fund will get out of the market if its professional managers think there's a serious risk of the market falling. Not true.

A pro can't afford to underperform against his competition, the other guys running active funds. In practice, that means almost all mutual funds stay almost fully invested almost all the time. No one can ever be sure if the market will be rising or falling, and a fund manager can't miss any of the rises. That's how he gets fired, because all of his competitors will have made money when he didn't. If the market falls, they all lose money together. Maybe he gets to keep his job.

Too many people have a false sense of safety with actively managed funds. You can't count on them to protect your money the way they would their own. They rationalize it by saying that if people didn't want to be invested all the time, they wouldn't have put their money into the fund. In reality, you're better off with an index fund. There, at least, you don't have any excuse for thinking that someone is watching out for you.

However, I don't think the case for index funds has the same validity when the comparison is with nonprofessionals trading for themselves.

Why do people do their own stock trading? Again, two reasons. First, it can be a lot of fun, plain and simple.

Second, I think people do it themselves because they want to be in control of their money. I've always thought that was a valid concern, and the recent abject failure of professional management and discovery of the Madoff and Stanford frauds proves its value. Most people didn't sidestep the market decline. Some did, and listening to Mad Money would have helped you dodge the fall.

The counter argument is that the ordinary guy is outclassed. He can't compete with the hedge funds and the big trading desks. They can run rings around him. Better to sign up with a pro, and let the big guys fight it out in the arena, without a lot of small fry underfoot being trampled. The picture makes sense...until you think about it.

There's no arena. No one's getting stepped on. Big guys have lots of advantages. Huge staffs, so they can operate 24/7. Enormous research capabilities. Access to a lot of very useful trading tools that an individual should stay away from (shorting, options, futures, other derivatives, black-box trading systems, and that's just for starters).

But they have some disadvantages, too. Their size is a major handicap. Trading billions is harder than trading thousands. The little guy is vastly more liquid than the big pro. They also suffer from the "politics" of professional investing, mentioned above. We believe that by picking the right stocks and knowing when to sell, the little guy can come out ahead. And the point of Mad Money is to provide the best possible coaching for all you individual investors out there.

For most of Wall Street's history, trading was dominated by what we would today consider "hobbyists." That was the norm. Maybe I'm too inclined to root for John Henry, but I'm not ready to pack in the old ways. There's never been a better time to do it yourself. It's cheaper, faster, easier. Do it all on the Web, if you like. Anyone sitting at home can instantly pull up more valuable information about the market than Jay Gould learned in a lifetime.

I'm surprised that in the 21st century, when increasing personal autonomy has become such an important theme, when we have a continuous worldwide garage sale on the Web, when every day, every where, in all aspects of our lives we're encouraged to think for ourselves, that in one area, managing our money, so many people think that this should be left to the "experts."

Please. You can do it yourself. Why we're the only ones making that argument, I don't know. Maybe it's because everyone in the industry has such strong financial incentives to let you leave your money to them. Maybe they just haven't thought it through. Either way, they're wrong.

Cliff Mason is the Senior Writer of CNBC's Mad Money w/Jim Cramer, and has been that program's primary writer, in cooperation with and under the supervision of Jim Cramer, since he began at CNBC as an intern during the summer of 2005. Mason was the author of a column at during 2007, which he describes as "hilarious, if short-lived." He graduated from Harvard College in 2007. It was at Harvard that Mason learned to multi-task, mastering the art of seeming to pay attention to professors while writing scripts for Mad Money. Mason has co-written two books with Jim Cramer: Jim Cramer's Mad Money: Watch TV, Get Richand Stay Mad For Life: Get Rich, Stay Rich (Make Your Kids Even Richer). He is 100% responsible for any parts of either book that you did not like.

Mason has also had a fruitful relationship with Jim Cramer as his nephew for the last 23 years and will hopefully continue to hold that position for many more as long as he doesn't do anything to get himself kicked out of the family.

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