What Is Smart Money?

Smart money is the capital that is being controlled by institutional investors, market mavens, central banks, funds, and other financial professionals. Smart money was originally a gambling term that referred to the wagers made by gamblers with a track record of success.

Usually, these gamblers had deep knowledge of the sport they were betting on or insider knowledge that the public was unable to tap into. The investing world is similar. The populace perceives that the smart money is invested by those with a fuller understanding of the market or with information that a regular investor cannot access. As such, the smart money is considered to have a much better chance of success when the trading patterns of institutional investors diverge from retail investors.

How Smart Money Works

Smart money is cash invested or wagered by those considered experienced, well informed, "in-the-know," or all three. There is little empirical evidence to support the notion that smart-money investments perform better than non-smart-money investments; however, such influxes of cash influence many speculation methods.

Smart money can refer to the collective force of big money that can move markets. In this context, the central bank is the force behind smart money, and individual traders are riding the coattails of the smart money.

Identifying Smart Money

Because insiders and informed speculators typically invest more, smart money is sometimes identified by greater-than-usual trading volume, particularly when little or no public data exists to justify the volume. Knowing who are the holders of smart money and where they are investing can be of great benefit to retail investors who want to ride the coattails of smart money investors.

Tracking methods group transactional data from commercial and non-commercial traders into various assets and markets. These "smart money versus dumb money" charts emphasize the stark differences in how the two groups position themselves in the market. However, smart and dumb labels are often exaggerated. On an individual basis, most professional portfolio managers and traders struggle to match the returns of blind index investing over time.

The Scale of Smart Money

Investors with large followings, such as Warren Buffett, are considered smart money investors, but the scale of their activities is not always taken into account. When the cash reserves at Berkshire Hathaway accumulate and are not invested, this is definitely a sign that Buffett does not see many value opportunities in the market. However, Buffett functions on a different scale. A $25,000 investment is not too significant in a billion-dollar portfolio.

Key Takeaways

  • Smart money is capital placed in the market by institutional investors, market mavens, central banks, funds, and other financial professionals.
  • Smart money also refers to the force that influences and moves financial markets, often led by the actions of central banks.
  • Smart money is invested on a much larger scale than retail investments.

Buffett's smart money acquires companies rather than taking a position. Institutional investors of Buffet's size need scale for overall portfolio impact. Therefore, even when the smart money is out of value picks in the current market conditions, it does not mean that there are no opportunities—particularly for modestly sized stocks.

Fast Fact: In the context of gambling, smart money refers to those who earn a living on their bets; many gamblers use historical mathematical algorithms to decide how much and on what to wager.