Why I’m Wary of Stocks

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Game of LifeJim Wang’s recent Bargaineering post “Why Fewer People Trust the Stock Market” inspired from me an “and-I’m-one-of-them” comment. Jim—a savvy guy who probably detected the prospect of one of those cranks who can really drive engagement—invited me to expand here on my reaction. I’m pleased to oblige.

We Do Own Stocks

First, disclosure: Stocks comprise about 15% of our (my wife and I) financial assets—far less than the “experts” would recommend for our situation. And nearly all the stocks we own meet two criteria:

  1. Based on the price we paid, their current dividend yields are 4-7%.
  2. The underlying businesses are mostly resource-based and operate in well-regulated industries. (In my opinion, regulation reduces risk.)

I’m not blindly or ideologically opposed to stock investing, but I stick with relatively safe, income generating stocks, and I actively manage stop loss orders as appropriate.

Why I Don’t Trust the Stock Market

Here are highlights of the foremost reasons I’m wary of stock investing:

Dangerous Games No One Understands I enjoy casinos, in particular blackjack and craps. I’ve studied the games, I know the rules, and I know the odds. I don’t play to make money, and I’m comfortable losing a little money because I have fun playing.

In contrast, I don’t understand the rules of the game on Wall Street. Moreover, I don’t believe anyone on the planet fully understands the mechanisms now in play on Wall Street. Effective regulation is non-existent. Financial instruments are invented and traded purely for sport and profit, with no underlying economic utility, no oversight, and no regard for consequences. The SEC, bless its heart, is pathetically under-resourced, outsmarted, out-lawyered, and out-classed. (It couldn’t even detect Madoff!) MIT PhDs madly work at supercomputers to institutionalize legal (evidently) larceny. And I’m supposed to entrust my retirement to this Mother of All Game Rooms? No thanks.

Algorithmic Trading Among the myriad examples of the gamesmanship that now dominates stock trading, I think algorithmic, or high-frequency, trading is particularly ominous. During the May 6, 2010 “Flash Crash,” after dropping 300 points over the course of part of the trading day, the Dow Jones Industrial Average plunged another 600 points—about 6%—in five minutes. Twenty minutes later, most of the 600-point drop had been regained. No definitive explanation of these events has been published, though algorithmic trading is generally regarded as having played a key role. This sort of thing troubles me.

According to financial services industry research and consulting firm Aite Group, in 2009 high-frequency trading firms represented 2% of the approximately 20,000 firms operating but accounted for 73% of all U.S. equity trading volume. Put on some Pink Floyd and check out this nifty video to quickly get a sense of the explosion in algorithmic trading, beginning especially in 2010.

The problem I have with algorithmic trading is two-fold: 1) No one grasps or is seeking to control its, potentially chaotic, consequences (see Knight Capital for only the most recent fiasco), and 2) I see algorithmic trading as yet another way that Wall Street aims to rob the forlorn individual investor like me.

Marketing, Not Money Management By an amazing coincidence, the Wall Street mantras piously preached to individual investors—buy & hold, don’t try to time the market, only stocks beat inflation, you can’t retire comfortably if you don’t put the lion’s share of your financial assets into stocks—also serve to grow and sustain Wall Street, magnificently. Wall Street’s explosive success is due not to shrewd and lucrative investing of individual investors’ nest eggs but rather to skilled marketers who excel most at self-promoting numerology. You need only watch CNBC—the network seemingly invented to convert the nation to day trading—for a few minutes to accumulate evidence: A merry-go-round of Wall Street Kool-Aid guzzlers and charlatans take turns shouting the lingo and pretending to have the ability to forecast reliably stock prices.

Unfettered Risk-Taking I opposed the 2008-09 financial industry bailouts. I don’t care if no bailout would have meant I’d have to live in a tent and eat wild berries and road kill for a few years, we’d be better off, if not today then some day, if the bailouts hadn’t happened, in my opinion. The big talk during the crisis of breaking up “too-big-to-fail” institutions like AIG has predictably fizzled (Wall Street funnels mountains of cash to both major parties). For risk-taking to be prudently self-managed, the risk-takers must keenly fear the consequences of failure. With the precedent now set that politicians will use taxpayer money as a backstop, Wall Street rightly feels insulated from the most significant negative consequences of risk-taking. The taxpayer backstop naturally serves as a recklessness incentive. How would you behave differently in a casino if you were gambling with “found money” instead of, say, your retirement nest egg or next mortgage payment? Another, and more catastrophic, meltdown is more likely today than in 2007.

Unjustified Costs As I’ve explored on Money Counselor, the impact of money management fees is to crush long-term performance. I keep asking and keep getting nothing for an answer: Is there any academic study that demonstrates professional money managers consistently outperform index funds, after fees and taxes? If the answer is no, then isn’t the entire active money management industry essentially a fraud? While this point is about active vs. passive fund investing, not whether to invest in stocks at all, in my mind it’s symptomatic of a culture of deception of which I want no part.

Nothing Beats Stocks? Bullfeathers

Those who make their livings buying and selling stocks have convinced individual investors that they’ll retire on a cat food diet unless they turn over to Wall Street a big chunk of their savings. We all know the self-serving arguments made by money managers (and commenters on this post will recite them all, so I won’t do it here). Two brief points:

  • In my view, the assertion that a financially secure retirement is tough to achieve unless one invests heavily in stocks is garbage, an illusion invented and carefully groomed by the Wall Street marketing machine. Are there alternatives to stocks? Of course! How about real estate? Starting or investing in a small business? Investing in education or training so you can boost your income? Investing in a side gig that will provide income, stimulation, and fun into your senior years? Choosing a low cost lifestyle so you can avoid expensive debt and save more income during your high earning years? Forming a strategy for a secure retirement that’s not overly stock-dependent is a cinch, for the open-minded.
  • Among conventional investments, only with stocks do you run the risk of watching a retirement nest egg go “poof” virtually overnight. If that happens in the latter half of your earning years or beyond, you’ve got a big problem, my friend. You’ll likely be dead (and poor) before you reach the Promised Land: The blessed “long run,” over which stocks always outperform everything, or so goes the sermon.

For further reading on stock investing’s risks, I suggest the book “Risk Less and Prosper: Your Guide to Safer Investing”, by Drs. Zvi Bodie and Rachelle Taqqu. To get a flavor, here’s a link to a Wall Street Journal Online piece written by the book’s authors. I’ll conclude with a couple of quotes from the article:

“Despite the assurances of the financial industry, stocks are always a risky investment, and the longer you hold them, the better your chances of getting blindsided by a downturn. The usual way of mitigating that risk, diversification, holds no guarantees, either—for the simple reason that investments don’t always move the way we want in relation to one another.”

“It may be hard to let go of the belief that buying and holding stocks is a sure-fire key to asset growth. But that’s because people have been lulled into thinking that long-term stock investing greatly reduces the risks. The truth is that stocks are risky no matter how long you hold them.”

This is a guest post by Kurt Fischer at Money Counselor.

(Photo: psycho-pics)

{ 25 comments, please add your thoughts now! }

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25 Responses to “Why I’m Wary of Stocks”

  1. NateUVM says:

    Kurt, this is a very well-reasoned description of your personal approach to stock investing. Thank you for your perspective.

    When you discuss alternatives to investing in stock with the aim of protecting one’s retirement, you list many viable alternatives… However, there is one component to all of them that make them more expensive than buying stock… Time.

    It takes Time to own/run a small business. It takes Time to own/rent real estate. It takes Time to invest in additional education/training. It takes Time to develop a side-gig via a hobby in the goal of turning a profit. In each case, in order to see any gain, you need to actively participate in order to see any return. There is opportunity cost there. Time IS money. The value proposition of these alternatives need be considered when deciding to pursue them over a stock strategy.

    Because with stock, after you buy, generally speaking there really is nothing else you “need” to do in order to realize a return (usually over the long-run). In fact, you can still work full-time while pursuing a return via stock ownership. Not quite as easy, with the other approaches…

    One could say you need to research your investment, and that that takes Time… But that’s a wash with the alternatives because hopefully you are doing research there, too.

    None of this is to say that one shouldn’t try out any of the approaches that you have listed. All good things to do to diversify your approach, etc… I’m merely using the hypothetical that one has an amount of cash that they are going to allocate to one of those activities mentioned. And that there are more investment costs associated with some of the activities that you’ve outlined than are illustrated in your post.

    • I partly agree. If one were to start a small business, that presumably would or could displace time spent on paid employment, so there may or may not be an incremental boost in time spent on the endeavor. Also, 100% of the return on the time invested would accrue to you, not a tiny slice (salary) of the return on time invested, as is the case with most paid employment.

      Stock investing surely requires significant time too, in my view, to do it properly, even passive fund investing. Or one could hire a financial planner and either 1) pay him or her a portion of any positive returns, or 2) further reduce negative returns, because the planner gets paid regardless of how you do.

  2. Russell says:

    In response to your question about active managers outperforming index funds, there have been extensive studies which show that active managers tend to underperform the index, especially when fees & taxes are included. See especially Malkiel’s “A Random Walk Down Wall Street” and some of the work by John Bogle, the pioneer of the index fund.

  3. Kurt,
    I certainly understand your resistance to stock market investments considering the recent shenanigans of some of the players.

    I’ve watched and participated in the stock market over the past 3 decades and have seen many cycles come and go. Personally we are better off due to our investments in the market – investments which we were able to do while pursuing other, more time intensive life events.

    Each family or person must analyze their own situation to determine when and how to invest money to better their situation. It is not one size fits all.

  4. I agree with you 100% Marie–I don’t mean to prescribe my approach for anyone, as we all have unique circumstances and priorities. At different points in my own life, my investing philosophy has differed greatly from what it is today, depending on my age, circumstances, and how I perceive external risks.

  5. This makes me feel better about how scared I am, Kurt. Also, new favorite word: bullfeathers.

  6. Having owned a business before, I really believe in the stock market as an investing opportunity. Not a gambling, trading or get rich quick opportunity, but definitely an investing opportunity.

    Especially if you focus on a few companies whose potential and managements you believe in. It has worked for us: my wife and I have had very good returns and we were able to retire on time after getting to the game very, very late. And we did it only with stocks. Can’t beat that! 🙂

    • A lot of people have made a lot of money because of equity investing, no question about that. (Many of them work on Wall Street.) I’m pleased stock investing has worked out so well for you, and for anyone else who’s taken the risk and seen it pay off. However, tens of thousands of people–who were only following standard investing advice–have seen their retirements postponed indefinitely or greatly diminished in quality thanks to the 2008 meltdown, scams a la Madoff, larcenous ‘management’ and other fees, and other risks they were taking without realizing it. Once someone has passed his or her peak earning years, living long enough to recoup major equity losses is at best problematic and at worst impossible.

  7. My husband recently found a time-lapse video and commentary regarding algorithms gone wild (my words, not theirs). It might have even been Knight Capital, because if I recall correctly he showed it to me around that time. I wish I had the link now. Anyway, that is my number one stock market fear.

    A couple years ago, after the whole 2008 ordeal, my dad started saying “I’ll only invest as much in the stock market as I’m willing to lose.” While that may be extreme, I think it’s important to remember how risky stocks can be. And as far as 7% inflation average over a 20 year time span or whatever the financial experts like to say, I counter with past returns do not guarantee future performance!!!

    • AH – 7% interest, not inflation. My goodness, let’s at least hope.

    • NateUVM says:

      Past returns do not guarantee future performance. 100% true.

      But that 7% return (or whatever it happens to be, depending on how you calculate and over what time), is generally cited as the overall return over the past 100+ years or so. That’s a statisticaly significant amount of time.

      The past decade has been a rough time to be an equity investor, for sure. Inppropriate allocation/risk pairings and inadequate investing knowledge (both on the investors part AND the advisors part) along with poor market performance have torched people’s investment accounts. Certainly a TON of bad luck for people moving shortly into retirement.

      It’s still important, though, not to go too far in reacting to such a small slice of market history. Was it such a wise idea, in the long run, for people to turn to stuffing their money into their mattresses coming out of the Great Depression?

      I do like that motto of your Dad’s… Don’t invest more than you are willing to lose. Kinda like, don’t drink the juice if you can’t handle the squeeze!

      Just remember that past performance (past 4 years) does not guarantee future performance (indefinite market declines).

  8. Excellent critique of wall street investing. People seem to have a mystical reverence for the stock market. This is a great post for demystifying an investment that people are far too comfortable in trusting.

    That said, I’m reminded my biggest non-stock market loss. My first venture as an entrepreneur came crashing down when a major supplier of mine ended their policy for offering free shipping. Like that, my first business ended.

    There are risks in all financial opportunities. If there weren’t there wouldn’t be hope for a return. I can’t think of a single investment where the potential for total collapse is not possible.

    • Thanks JP. Entrepreneurship is surely risky, no doubt about that. Perhaps this is a difference without a distinction, but to me suffering a quick financial loss in the manner you did–a critical piece of my own business model being undermined by another company’s business decision–feels a lot different than losing big money because of hyper-greedy money managers’ uncontrolled obsession with exploiting individual investors and “the market.”

  9. Hey Kurt. I understand why stocks make you nervous, but the best time to invest is normally when it’s the least comfortable. I’m the author of a book called Investing 101, first published in 2000. At that time, I was telling people to be nervous about stocks — that they couldn’t repeat their performance over the past two decades and were likely to either plunge in value or languish for a long time. They did both. Now, I’m fairly optimistic. I expect the markets to remain volatile, but there are many fundamental reasons to believe that stock prices will “revert” to normal returns, which based on the 82-year history tracked by market historians at Ibottson Associates, is about 9.9% per year.

  10. Greg says:

    If not the stock market then where? The bond market? Commodities? Real estate? Cash? With the exception of cash, all those markets seem equally risky, complicated, and volatile compared to the stock market.

    Passive income generation is essential when planning for a retirement that in all likelihood could extend beyond 20 years. What other strategy would you advocate for accumulating wealth?

    Yes, there is risk in the stock market. There is also risk in doing nothing.

    • NateUVM says:

      The author actually provided several alternatives to investing in stocks in the section titled “Nothing Beats Stock? Bullfeathers.”

      • Thanks NateUVM. And as JP has pointed out, several of the suggestions I made carry significant risk. I did not mean to imply otherwise, of course. But many other opportunities to build a retirement fund are low risk, especially compared to stocks. Avoiding excessive debt, living well below one’s means, investing in education and training to maximize and prolong earning power, and choosing a low-cost lifestyle can and will each contribute meaningfully to a retirement fund, at no or quite low risk. Once CNBC is turned off and the mind opened, opportunities abound for saving for retirement without investing heavily in risky equities.

        • Greg says:

          All of those ideas are wonderful, foundation building ideas, but as you live a low cost lifestyle, where do you park the accumulating cash? What passive income generating vehicles are there that keep pace with or even out pace inflation? How do you accumulate wealth without participating in some of these crazy and admittedly flawed markets?

  11. The stock market is always going to be a bit of a gamble so don’t invest money you can’t afford to lose or have tied up until the market turns. Look at Facebook stock. When the company went public the stock was at something like $42/share back in May and now 4 months later, the price is only $21/share. That 50% drop is bad for the people that bought Facebook shares back then, but it can be a great thing for people now, if you believe in the company an their potential for success and innovation.


  12. Shilpan says:

    “Wall Street’s explosive success is due not to shrewd and lucrative investing of individual investors’ nest eggs but rather to skilled marketers who excel most at self-promoting numerology.” — simply fabulous thinking, Kurt. My street smart philosophy in life is to do exactly opposite to what masses do; and you know that masses get their rituals from CNBC.

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