Hope for your financial life and beyond

The Difference Between a Dumb and Smart Money Investor

Well, we’ve reached that point again in the stock market where indices are at high levels again. The NASDAQ composite index touched 5,000 the other day, its highest level since the year 2000. It’s just a stone’s throw away from its all time high, making it the last of the three major indices to reach an all time high at some point during the current bull market.

So, right on cue, out come the headlines warning investors of an impending major pullback in the market. One in particular caught my eye the other day. It read:

Why the Smart Money is Bailing Out of the Bull Market

As an investor, how does that headline make you feel? Does it encourage you in any way? Are you feeling good about your investment strategy and how its playing out in the market right now? Getting the urge to go sell a few stocks?

I guess the answer to that question depends on whether or not you consider yourself a smart money investor.

What is a Smart Money Investor?

You may have heard the terminology smart money thrown around from time to time. Do you know what it means? Well let me assure you that in the context of investing, it has nothing to do with how knowledgeable, bright or intelligent you are.

dumb or smart money investorSmart money refers to money that is invested by financial professionals. These would be people on the inside of the industry whose profession it is to investigate, learn about and track the trends of stocks and the market in general.

They pour over company financial statements. They calculate PE ratios. They analyze the labor markets and scrutinize government policy. These people immerse themselves everyday with endeavors like these in an effort to anticipate the future direction of stocks.

So when the headline reads the smart money is getting out of the bull market what it’s really saying is that the analysis of these financial professionals has led them to conclude there is risk of a major market correction. Not wanting their clients to lose any money, they advise them to sell stock investments. When the market corrects (goes down) they can buy back in at a lower price point.

In that regard the smart money is routinely moving money in and out of the stock market in order to achieve the highest possible return. It’s very focused on what the market is doing on a day-by-day, week-by-week and month-by-month basis.

Why should we care about this? Well, were we to track the buying and selling habits of the more experienced professionals, it would stand to reason we would have a better chance of making money. So goes the theory.

What is a Dumb Money Investor?

The contrasting term dumb money (which you rarely ever hear referenced that way because of its negative connotation) refers to the money invested by the rest of us. The retail investors. The outsiders. The non-professionals.

Dumb investors don’t make investing in the stock market their daily passion. They are more likely to take a patient, long-term approach to investing. In general, they would not be concerned about market highs and lows. They would look to invest continually, regardless of stock price or market levels.

In essence, dumb investors are those who aren’t tracking the daily minutia of the stock market and consequently are not making the best choices with their money.

That’s the implication, isn’t it? If it’s not the implication, don’t you feel that way just a bit when you read that headline?

The Impact of the Terminology

By categorizing investors into smart and dumb categories we are clearly saying that one group has a more informed opinion. Due to their time, access and study of information the smart investor can make better investment choices. The dumb investor just doesn’t have a shot and is always one step behind those in-the-know.

For me, the terminology that is used to describe the classification of investors is wrong. It has a negative impact in that:

  1. It produces feelings of inadequacy for non-professional investors.
  1. It promotes a follow-the-herd mentality as the dumb investors chase what the smart investors are doing.
  1. It minimizes personal development. (See #2) Why learn if I can just blindly follow?
  1. It fosters a mentality of us against them (big city finance gurus – aka the rich vs. small town average Joes – aka the not-so-rich/poor)
  1. It tempts “dumb” investors to make unwise, panicked decisions.

The emotion surrounding the words smart money would probably all go away if we just removed the term form our investing lingo. Use a term like professional or business or trader’s when linking it with the word money. Those aren’t catchy terms but at least they don’t create instant negativity and an obvious division.

When I see those more generic terms I only think the insiders are doing what their profession calls for, which is making money for their clients. I don’t see it as implying their investing decisions are smarter than my own.

Because here’s the thing…laymen can be smart too.

Laymen Can Be Smart

My pastor is really knowledgeable about the Bible. He studies and writes more about it than anyone I know. If you don’t believe me check out the commentary he’s been building for nearly a decade.

Being a pastor is his profession. It’s his job to share his knowledge with the congregation and guide us into making better decisions. He wouldn’t be doing his job it he didn’t get us to think about what lies ahead.

I’m merely a layperson. I have no specialized education or training in understanding the ancient Hebrew or Greek text of the Bible. I’m a non-expert – an amateur when it comes to those things.

But I can still learn on my own. In fact, an individual study of the Bible is one of the hallmarks of someone who is continually growing in their faith. It’s what leads to wise life decisions for the present and future.

The same can be said of investing in the stock market.

Just because you or I are not professionals doesn’t mean we can’t learn. It doesn’t mean we can’t have success based on that learning. And it doesn’t mean that what we conclude about our style of investing is wrong compared to what the “smart money” is doing.

I’ve been investing for about 20 years. In my mid-to late 20s I was pretty green with investing. On more than one occasion I stubbed my toe with the best of them by making rash and hasty decisions. Mostly I was listening to others and following the daily gyrations of the market.

Because of my mistakes and desire to learn my investment approach changed. Now I’m a long-term investor who likes to park his money in investments that will grow over time. I’m not interested in tomorrow or next month or even next year. I’m looking 20+ years down the road.

Since my shift in investing philosophy, I’ve done pretty well. I wouldn’t consider my long-term, buy and hold strategy dumb by any stretch of the imagination. In fact, I’d call it a very smart approach for anyone to take, even those professional in the finance industry.

But they would never hear of that. Their focus is near term. So when they see the NASDAQ at an all time high of course they are going to sell. It’s coded in their DNA.

You don’t have to get roped into that approach because you hear or feel it’s the “smart” move. Remember the term smart money only refers to the money invested by professional individuals. It has nothing to do with you being dumb.

In fact, there is plenty of evidence to conclude the smart money professional investors don’t fare very well with their strategy. They have trouble outperforming the market too, even though they are privy to more company information than you and I.

I find that…well…pretty dumb.

Questions: How do you feel about the term smart money? Does it rub you the wrong way? Is your investment strategy near-term or long-term focused? Do you get squeamish when the market is at an all time high?

Image Credit: Lending Memo

Next Post: Give Money and It Shall Be Given to You?

Prior Post: Dodging Sex and Money Conversations With a 6-Yr. Old

I hope you enjoyed that post. Want more?
Sign up to receive my blog posts via email and get your free gift...
99 Ways to Spend Less and Save More

Privacy Guarantee: I will not share your email with anyone.

Comments

  1. It definitely irks me. New investors see the term “smart” and think that is the way you have to invest to make money, when stats show that active investing doesn’t live up to the hype. I’m a seasoned investor who invests in passive index funds. I buy all of the time, both in up and down markets and I stay invested all of the time, both in up and down markets. I’m fine with being called “dumb” because I understand how the market works.
    Jon recently posted…Motif Investing Review: A Game Changer For InvestorsMy Profile

  2. This is why I focus on asset allocation and rebalancing with my clients. As long as we have the right asset allocation in place, we don’t have to worry about smart and dumb money, we know that the allocation is right for their near and long term goals and when the percentages shift due to market fluctuations, then we rebalance and sell. We let the allocation drive our decisions over the markets.
    Shannon recently posted…Women’s Power WednesdayMy Profile

  3. Scott W says:

    I agree with you on the smart money term but I don’t lose sleep over it.

    I think the “smart money” take much bigger chances with timing the market and leverage which I’m not willing to do. Some times their risks pay off huge and some times they go broke. I’ll stick with slow and steady and let the great Jack Bogle help me get to where I want to be.

  4. Maybe we are dumb, but during the market pull back in ’08 my husband and I did not lose anything other than a net worth number written on a piece of paper. We held all of our stocks and bonds because they were dividend and interest payers so our income from those investments just kept right on coming every quarter without fail. We had invested in companies with high safety and financial strength ratings and whenever we could we invested more money into those instruments because with the lower price, the yield was great. The ones we consider “dumb” are those who rode the index all the way to the bottom then bailed out at a low point and then waited until it went back up to get in again. We don’t buy the index. We buy the company. If that’s dumb, I guess I’ll just have to live with that moniker.

    • “…rode the index all the way to the bottom then bailed out at a low point…” I agree Kathy…that’s the worst thing you could have possibly done in that time period. We did very little with our investments then. We rode it all the way down – buying all along the way – and then rode it back up, continuing to buy. Those shares we bought at such low prices are looking really nice now.

  5. I saw the same article about the NASDAQ and just shook my head. I heard the “smart investor” term all the time when I was in the brokerage industry. It always drove me a little nuts because while I understand what they’re trying to say, I would think about how should this impact how we treat retail investors – not even to mention what it’s communicating about them. Like you pointed out Brian, just because we may not be “professionals” when it comes to the investing industry, we can still very much inform/educate ourselves so we can make wise decisions. As to my strategy…it’s boring and long-term.

    The other thing that drives me batty is the talk about an index being at a “high” – like somehow, magically, the market is guaranteed to never go above that and assume a definite pullback. That point of view just shows the thinking is off – who cares where it is today or tomorrow? We should be concerned with making wise decisions and sticking in it for the long haul.
    John recently posted…Are We in a Race to the Bottom?My Profile

    • I think there is a real danger for the retail investors to buy into this terminology and act on it. Not only are you not learning yourself but you are still one step behind the “smart” investors. By the time the news is out that they are selling, they’ve already sold their positions. So the retail investor never is ever to act in the same moment of time as the insiders.

  6. I don’t care too much about the terminology. We are indexers too so our investing strategy is pretty simple. We always invest whatever amount we decide on at the beginning of the month.
    Holly recently posted…Sometimes It’s the Little ThingsMy Profile

Speak Your Mind

*

CommentLuv badge