Here Is Why Professional Investment Advisors Are Overrated

This article is an excerpt from the Shortform book guide to "One Up On Wall Street" by Peter Lynch. Shortform has the world's best summaries and analyses of books you should be reading.

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Have you always wanted to invest but felt like you don’t have enough expertise or acumen? Are you considering the services of a professional investment advisor?

Many people who aren’t well-versed in finance believe they need professional advice to invest profitably. However, professional investment advisors don’t possess any secret knowledge about the market. In fact, they tend to err on the side of caution when giving investment advice, and cautious advice means moderate gains.

Here’s why professional investing advice is overrated, according to Peter Lynch.

Professional Investors and Firms Aren’t Flawless

Lynch argues that professional investment advisors can lead you astray because they’re often misguided or operating from high-minded theories, rather than on-the-ground experience.

(Shortform note: What exactly is a professional investor? The term can apply to day traders, people who trade stocks in their portfolios as a career and chief source of income. However, the term more commonly applies to financial advisors who advise a set of clients and help them develop a better portfolio.)

In part, this is because professional investors face the following obstacles, according to Lynch:

Delays: Most professional investors only buy stock once other investors or firms have done so, and it’s therefore a proven good investment. This means they’re not free to leap on early opportunities, when the stock price is low.

Reputation management: Professional investors have a greater incentive to stick to safe, established companies because they risk less professionally. Investment firms also often like to prioritize parity over profit, spreading investment success somewhat equally among clients so clients don’t become upset if others’ portfolios do better than theirs. The result is that when you allow an investment firm to make investing decisions for you, you’ll likely only ever make moderate gains.

Restrictions on what they can buy: Many investment firms don’t invest in companies that have unions, operate in certain industries, or follow other relatively arbitrary rules. Further, the SEC imposes restrictions on what firms can buy. This limits the range of companies they’ll invest in for your benefit.

Overcoming Obstacles to Investing: Hedge Funds

The delays and inefficiencies Lynch mentions are less of a problem for hedge funds, which exploded in popularity in the 1990s and early 2000s and exist as an alternative to mutual funds. Both hedge and mutual funds are portfolios that an investor manages for clients based on a specific strategy. However, while anyone can invest in a mutual fund, only high-net-worth investors can invest in hedge funds, making them private.

Hedge funds, though now somewhat suspect organizations in the eye of the general public as a result of recent instances of illegal insider trading, have several advantages over, for instance, mutual funds:

First, hedge funds are funds open only to “sophisticated investors”—in other words, high-wealth investors. Because such investors have more financial flexibility than the average person (and because they’re considered to be savvier investors than the average person), there are virtually no restrictions on hedge fund investments—as long as the managers remain within the confines of legality. Thus, hedge fund managers have tremendous freedom in how, when, and what they invest in and what strategies they employ to do so (and these strategies tend to be quite risky).

Further, hedge fund managers are considered to be more astute and connected than the average investor. Many hedge funds hire people with PhDs to increase their competitive and intellectual advantage and constantly strengthen ties to people and organizations with power or information. For this reason, a hedge fund doesn’t have to work as hard to maintain its reputation—and in fact, its reputation is based more on its ability to engage in smart, risky behavior than safe behavior.

Here Is Why Professional Investment Advisors Are Overrated