Dumb: “Don’t invest; you can’t beat the pros”

September 09th, 2005 - 25 Comments

My oh my, I have heard this idea many times. I was giving my finance talk at Intel last month, and afterwards, one of the employees and I started chatting. He told me about his uncle, who had built some kind of technology firm and sold it for $100 million. Obviously a smart guy, no doubt about it. But then his uncle told him to never invest in stocks because–that’s right–”you can’t beat the pros.” In other words, those guys on Wall Street do this every day, so how can the lone, individual investor hope to compete?

I didn’t want to insult this guy’s uncle, but after fumbling around for a polite phrase, I just told him that his uncle had no idea what he was talking about. (Oops.) Look, being a CEO doesn’t make you an expert on gardening, making spaghetti, or doing my laundry. Same with individual investing and personal finance.

Now, I agree–the guys on Wall Street (and they are almost all guys) work an ungodly amount and know what they’re doing. But they don’t have the same objectives as individual investors, nor do they go about achieving their goals in the same way. Let me break it down: Wall Street looks for quick profits that are built on fees, existing relationships, and extremely sophisticated sales and trading strategies.

In fact, as Jim Sinegal (CEO of Costco) recently said,

“On Wall Street, they’re in the business of making money between now and next Thursday,” he said. “I don’t say that with any bitterness, but we can’t take that view. We want to build a company that will still be here 50 and 60 years from now.”

I like Jim!!!!!

Compared to Wall Street, individual investors like you or me should be looking for long-term growth.

In other words, if you try to beat Wall Street at its own game, of course you’ll lose. Uncle Billy is at least right about that. But smart individual investors play an entirely different game than Wall Street.

Wall Street Individual Investors
Strategy Gigantic profits through fees & relationships & and sophisticated sales/trading Long-term growth through diversified investments (e.g., buy and hold)
Hours worked A lot A lot less: A few hrs/month after you create a good infrastructure
Type of food eaten Filet mignon at the Four Seasons Taco Bell (I will eat this till I die)
Barriers to success Very high–interviews, Ivy League degree often required, “hard work every day” Moderate and decreases over time: Read this site, a few other financial guides, and manage your money with the proper risk/time perspective

I’ve said this before and I’ll say it again: When someone says, “I don’t invest in the stock market. It’s too risky!” it’s not as if they’ve carefully weighed the risks/rewards and educated themselves about personal finance. That’s like me saying “Honestly, I prefer fossil fuels over energy cells and nuclear energy as a matter of personal preference.” I literally have no idea what that means, but I bet I could pass it off as haughty and scoff at you if you disagreed. Ugh.

The people who are afraid of the stock market are almost always the same. Their view is a guttural, emotional reation that is ultimately self-defeating. I can only offer my gold-crusted throne in 15 years as proof.

So when you hear someone saying that you shouldn’t invest in the stock market because you can’t beat Wall Street–that’s why they don’t–recognize it for what it is: an excuse to not get educated about properly investing and managing risk over the long term.

And if you’ve read this far, that’s one more excuse you can cross off your list.

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25 Comments

 

Comments

  1. The market is efficient, by the time the general public has heard of market swinging news, everything has already adjusted, and then some! It is important that readers interpret the efficient market theory. But it is just that, a theory.

  2. I don’t know what you mean by “beating Wall St.” Successful investing is not about “beating” anyone–it is not a zero-sum endeavor.

    Successful investing comes from following a plan that is based upon the individual’s objecitves and risk tolerances. It doesn’t matter what others are doing.

    For the last eleven years I have worked for two of the largest firms on Wall St. and can tell you that your impression of it is way off. Where did you get your information?

    BTW: I love Taco Bell!

  3. thc…

    Isn’t that exactly what I’m saying? Forget about Wall Street’s goals (and anyone else’s) because they’re undoubtedly different than yours. Focus on your own goals because personal finance is just that–personal finance. I don’t think we’re disagreeing here.

  4. No Wall Strreet’s goal is to see its clients prosper, many of whom are individiual indvestors. Again, where do your impressions of Wall Street come from?

  5. thc is right on. theres no one to “beat” on wallstreet. only options trading is a zero sum game.

    you can use institutions to your advantage with the “free ride” effect. buy a stock thats being accumulated by institutions. after the accumulation and consolidation period, you’ll get a free ride as the stock is cut loose.

  6. Wall Street also has a fiduciary responsibility to its shareholders to make profits. I’m not saying they don’t want to help their clients (of course they do), but when dealing with individual investors, they have to make money.

    I get my “impressions” from the same place as everyone–first, when seeing my parents’ financial stuff, then my own interactions with WS firms, then a number of friends who work at WS firms. And from keeping up to date on the business side of it by reading a ton of stuff every day.

    Using Wall Street resources can be good for some people. But the whole point of this site is that you don’t need them to be smart about your personal finances and investing.

    And let me reiterate that I AGREE that there’s no one to “beat” on Wall Street. Look at the title of this post!

  7. One hugely critical point you also left out, besides the totally different game that the Wall Street mainstream plays (which is a very good one) is that they operate on a hugely different scale. When Morgan Stanley eyes a great stock buy/sell, it takes them weeks to execute and they STILL stand to significantly influence the valuation by their own action. This difference in scale, combined with the difference in time scale (next Thursday vs. 20 years from now, as you already pointed out) is why they play an entirely different game, and why it’s, in fact, almost easy to beat them. Well, beat them on trades. No doubt they make assloads of money from fees, the likes of which you and I could only dream dastardly, underhanded and monopolistic dreams about.

  8. I’m getting the feeling that the point that everyone is trying to make is that comparing individual investing strategy with Wall Street investing strategy is like comparing apples and oranges.

    And conversely, just like there’s nobody to ‘beat’ on Wall Street, there’s nobody on Wall Street who sees you as a threat that must be squashed just because you bought a few stocks.

  9. I’ve found that there up to 2 day delays between when a stock has a big positive event and when people buy it. The only thing is that it is difficult to keep up with the news. I used to do it when I was a grad student.

  10. When you buy Berkshire Hathaway, you’re paying for an expert in Omaha. And history has shown he’s one of the best on earth. And he eats at Dairy Queen. He’s an expert and he’s the second richest dude on earth. You’re gonna beat him? You’ve got an over-convidence problem. Sounding authoritative and a bit contrarian simply isn’t enough to get rich!

  11. actually, trading stocks (which is how i supplement my income), IS a zero-sum game. if someone is “winning”, someone is losing. that is a basic tenet of the market. LOL. sorry to burst your rainbow colored bubble, thc….

  12. i think you’re a bit off there frankie cooper. who’s the loser when i’m “winning” off of let’s say a purchase of wal-mart stock in the late 70′s? let’s arbitarily say that i gained 10000% (totally random number obviously) in this “winning” investment. based on what you said, someone else lost 10000% (you might’ve MISSED OUT on 10000% of gains for not investing in Wal-Mart, but that’s an opportunity cost based on your decision to not invest in Wal-Mart…you didn’t lose any of your hard-earned cash). plus, i didn’t buy all of my shares from one corresponding shareholder, and even if i did, who’s to say that that shareholder sold at a loss? johns wu hit it on the head saying that options (and i’ll add futures) are really a zero sum game. there are two parties to a futures transaction. one buyer, one seller… one winner, one loser

    happy investing

  13. franl – i must apologize. i am stuck in the mindset of a trader. (which is good, i guess, because that is what i strive for..)
    i retract my original statement that the market, in its entirety, is a zero sum game. MY particular style, however, involves a zero sum essence. in trading, though, i must say that it does matter what others are doing. it matters a lot. LOL.

    happy INVESTING.

    :)

  14. Taco Bell might kill you, though

  15. Frankie,

    The market isn’t a zero-sum for sure. Consider that it averages something like 10% per year, so some people make 5% while others make 15%, it’s zero sum in that respect

  16. You might die soon if you keep eating that Taco Bell…LOL

    Stay away from E-COLIchiladas…

  17. Zero sum game??? Come on guys – stocks, options, futures, bonds – none of it is zero sum. Have you forgotten about commissions and even more importantly taxes? If you want to add your broker’s and Uncle Sam’s cut back in, then its zero sum. I haven’t heard of anyway to do that though.

  18. I have had the same experience; indeed it does tend to be folks who have no idea what they are talking about and are responding to the unknown from a place of ignorance and fear (was that too harsh?). A great way to dip your toe into the market is with a basic index fund/ETF. Get’s you a nice core fund at a low cost/turnover and you can see how it works (e.g. you can see how much more $ you are making instead of having it sit on the sidelines). But that’s just me.

  19. In the long run- and I mean the LONG run- if you’re careful, you can match the overall earnings of the economy- and that’s not bad at all. Put your IRA or 401K in ETFs that track the DJI, the S&P500, and the AMEX, and you’ll do okay. As you approach retirement age, you might start moving money into divident paying funds and treasury funds in order to reduce volitility.

    A lot of people seem to think that “investing” is synonymous with striking it rich. If they’re not hitting the jackpot, they’re doing something wrong. These are the people who endlessly shuffle their money around, read books on investing strategies, and will justify bad investments with nonsensical “technical” talk as they watch their account go to zero.

    You might think you can do better by gambling. You might try following a few industries obsessively and moving funds in and out of the market when you think it’s over or undervalued. But you will probably eat it all up in transaction fees and bad timing.

  20. I am a Canadian so just want to share with readers like me who don’t earn in U.S. dollars but have bought or are thinking of buying an S&P500 index fund…

    “The Easy Chair S&P 500 index since 1997 and the overall return is a more palatable, though hardly stellar, 4.9 per cent, once the ups and downs of the loonie are taken into account.”

    Full article: http://www.thestar.com/Business/article/215799

    I remembered seeing $1 U.S. dollar used to be $1.5 CAD at some point in the last 10 years… currently it’s $1 U.S. to $1.08 CAD (May 21, 2007) – that’s a 42% diff!

    So, calculating your S&P index fund ROI is not as straight forward as it appears and may not be your best investment choice b/c of the exchange rate factor.

  21. Don’t invest, ’cause you can’t beat the pros….that’s rich. Why not invest alongside the pros. That’s why you buy mutual funds and investment managers…to have them do your investing for you. But please don’t tell me you’re not going to invest because you can’t beat the pros. You would be more credible and sound less “damaged” if you just said “I’m not going to invest because I am too lazy to learn about it.”

  22. Well, we cannot beat the market for the long run, but how about being “with” the market for the long run ? Investing in total market index funds (domestic, international) does not require a Ph.D degree to understand. One can start investing in no load, low cost index funds and do as good as 75% of the pros in the long run (more than 15 years).

    Stocks (as in total market) have high short term risk (capital depreciating). But history has shown that stocks are agnostic to long term risk (inflation).

    “Stocks for the long run” by Jeremy Siegel has good discussion on this. I am sure there are many more books, but I just like this one. :-)

  23. So I’m a girl working on the Street (the original one in Philly) and can’t tell you how many haters I deal with who don’t work in this business who think we are a bunch of hacks. I love what I do (I’m writing this from my office on Memorial Day) and like any other industry, Finance has it’s annoying moments. But it provides a valuable service and not participating in the markets – in the long run – is not wise. I liken it to learning a foreign language. It’s daunting at first and nothing makes sense but the more you practice it and use it in your daily life, the easier and more familiar it gets.

  24. I think of wall street more as beating the odds than playing with the big boys from Lynch. You are right though that investor firms look to make quick profits and change investments rapidly. Personal investments are looking to play the market and build their financial portfolios as much as possible over the span of their portfolio.

  25. being not very tolerant to risk does not have to be a bad idea. i have lost money (with a good mutual fund) recently because of the recession, and i am glad that i have invested more of my money safely, ie i have lost only a fraction of what i would have, had i put it all into stocks. i still keep the remaining money in the fund, hoping that in 10 years time it might grow back, but probably will not do any risky investmens in the future.