The government is reportedly close to filing charges in the largest institutional insider-trading investigation in history.Â
According to initial reports, the investigation could ensnare Wall Street's biggest names: Goldman Sachs, SAC Capital, Wellington, Jennison, MFS Global, Maverick, Citadel, and others. (Here's a who's who of who might get nailed.)
The investigation reportedly focuses on "expert networks" -- consulting firms that pay industry participants to share insights and information with investors. Professional investors use these networks to gather information about real-time business conditions and trends in various industries (as well as, sometimes, information that could likely be characterized as "inside" information in any other context).
No matter where the investigation ends up, the government will likely present it as a huge step toward making the market "fair" for small investors. And the same small investors will likely view it as confirmation that the "game is rigged."
Both of these conclusions will miss a far more important point.
The REAL lesson most investors should take away from the largest institutional insider-trading investigation in history is that competition in the global financial markets is so intense that it's basically idiotic to trade.
Trading is what is known as a "zero sum game." To win, you have to beat the competition. (And you have to beat the competition by more than the amount that it costs you to trade, which is extraordinarily hard to do, especially after tax).
In our experience, most investors have no appreciation for how intense their competition is. They think, "Wow -- look at all this information I have. Look at all my trading screens. Look at all my SEC filings. Look at my charts and graphs. Look at the smart fellow on TV telling me what to buy.* Look at how many of my trades have made money!"
What they miss is that their competition has all this information, too -- so it doesn't give anyone an edge. They also don't understand that, in addition to all this information, the folks they are competing with have millions and millions of dollars to spend gathering information that will never be published anywhere or appear on a screen or in a chart or graph.
That's where the expert networks come in. That's where contact networks in general come in. That's where one-on-one meetings with managements and suppliers come in. That's where having dozens of smart research analysts on your team comes in.
One glance from a CEO in response to a pointed question can contain more information than 500 pages of SEC filings. One nugget of scuttlebutt about the status of an important contract can make you more money than 500 hours of studying charts and graphs. Most small investors don't understand that their competition gets this sort of information all day long.
In short, it doesn't matter whether the trading game is played on "a level playing field" (and of course it isn't.)Â The New York Jets will still destroy any high-school football team, no matter what field the game is played on.
From the perspective of small investors, the game that is played every day in the global financial markets is equivalent to the New York Jets vs. a high-school football team. And it should be no mystery which team the small investors are playing on.
So what's the smart answer for small investors in a world in which the competition is so unbelievably intense?
Don't play the trading game.Â
Instead, play a game you can win.
What's that game?
Long-term investing, preferably via low-cost, tax-efficient index funds.
Unlike professional investors, small investors don't have to worry about their performance in a given week or month or year. They can avoid the second-to-second warfare that defines the professional investment business. They can be patient and allow Ben Graham's long-term "weighing machine" to eventually do its work, rebalancing their portfolios to take advantage of the market's never-ending cycles of fear and greed along the way.
If they do that, and keep their costs low enough, they'll outperform 75% or more of the professionals.
Just as important, they won't be willingly playing a game they are almost sure to lose.
See Also: 8 Reasons Why You Should Never Become A Day Trader
Follow Henry Blodget on Twitter: www.twitter.com/hblodget
Michael W. Hudson: 16 Cents on the Dollar: Doing the Math on Angelo Mozilo's Big Settlement
Richard (RJ) Eskow: Wall Street Noir: Moody's "Double Agent" Ratings
Michael Rose: Inside Job -- a Caper Movie for the Financially Inclined
I've averaged just a shade over 8%/annum after tax over more than two decades. Not too exciting, I'll admit, but it's sure helped set up my wife and me with a comfortable retirement.
I say all this only to point out to younger investors that in twenty or thirty years time, you'll be twenty or thirty years older, and a "steady as she goes" approach will make a huge difference to your quality of seniors life while lowering - but of course, not eliminating - the risk.
One other thing I'll mention is this, I've always beleived that it makes sense to support real businesses that create genuine value, because, in the long run, they're the businesses that will create solid jobs and support our economy.
The argument for investing in index funds has nothing to do with professional investors being *better*. In fact, the argument is that professional investors do *not* beat the market, and that the fees charged by managed funds eat away the returns. I am not claiming that the typical pro-index fund argument that professional managers don't outperform the market is correct or incorrect -- only saying that the argument for index funds about professional manager returns is opposite to the argument in this article.
Instead, what we can conclude from the article's argument is that we're damned if we do, damned if we don't. If index funds did better than the returns professionals can get by the above methods, then they would be investing in index funds. We can't "win" by investing in index funds -- we can only fall behind the wealthy, who can afford the above methods, less quickly.
Only if you trust those professionals, who continue to make money, no matter what they do, no matter how much of your money they lose "for" you.
You remain correct in writing, "... we can only fall behind the wealthy... less quickly."
Unless we start arresting the richest rich the world has ever known.
If you want to invest, they have places for that.
Wall Street is not the place for either.
Consumer confidence can only be regained in the markets when and if:
1) Level the playing field for all - no more high-frequency trading, unintelligible derivates, or privileged hedge fund instruments. No more secrecy.
2) Everyone pays the same tax rate on all their earnings. Period. No caps, limits, or exceptions - yes, even hedge fund managers.
3) Regulate and Prosecute bad actors that undermine confidence and integrity of our financial systems and our economy. Repeat offenders will be excluded from any investment activity. Claw back any ill-gotten gains, plus penalties immediately.
That is the cliff notes of what I would like to see. But, if that is not possible (And given the Congresses reluctance to engage in any meaningful changes, I don't see it happening.) I will settle for your option as a start.
Today, stock are a commodity, not an investment. The same type of mind set was also partially responsible for the housing crash. People were purchasing houses not as a place to live, but as a commodity. A product to buy low and sell high. Which skewed the values of all homes.
I would not be surprised to see the market tumble also, if or when, we ever switch back to an investment minded approach to the market.
Article is right: don't trade stocks, invest in a mutual fund. Even with no insider trading it's better.
investment to grow.
the gurus were pumping these losers right to the end ---