Market Analysis

Free to Fail

Markets have never been more democratic, for good and ill.

Despite what some claim, the vision of stock market investing as a white-shoe club populated mostly by the super-rich trading among themselves for their own exclusive benefit has been a fallacy for decades. Stocks are a common fixture of modern life for the majority of Americans. According to Gallup, more than half of Americans have owned stocks in every survey they’ve taken since 1999. When you take into account the costs, access, information and transparency, never before has the investment industry been more democratized—individual investors find a more level playing field than ever. However, access doesn’t always mean success, just as lack of success doesn’t mean the market is rigged.

Prior to 1975, commissions were fixed according to a set schedule, a system governing Wall Street since 1792’s Buttonwood Agreement. Brokers simply agreed not to compete on price below a certain floor level. But on May 1, 1975, the SEC’s “May Day” reforms took effect, changing the brokerage landscape for the better by banning fixed minimum commissions. This, in turn, gave birth to discount brokerage, and price competition brought trading costs down industry-wide over time. The 70s also brought no-load and index funds—innovations that helped further drive down retail investors’ costs. In the Internet revolution, online brokerage shook the industry. Trading costs cratered. Investors gained transparency, the ability to see their account move in real time. Less visible trading costs like bid/ask spreads—the gap between what a buyer is willing to pay and a seller sell—fell markedly too. NYSE spreads averaged 22 cents in 2000, falling to 5 cents by 2003. How can you see all this yourself? Google it!

All this makes the little guy’s buck go further on Wall Street, but it doesn’t say anything about whether those bucks go further up or down. Lower costs are a plus, but they may also make it tempting to trade more frequently. There is a bevy of research suggesting a high frequency of trading is a detriment to returns. Making more decisions isn’t great if your error rate is high. Does this mean higher commissions are better? Certainly not! It simply means folks respond to incentives, and they sometimes respond with behavioral errors. The same effect applies to no-load funds—no costly barrier to trading can mean more frequent fund flipping. There is no evidence fund flipping helps returns and ample evidence holding for too short a time period hurts. Higher fees aren’t good for investors, but low costs are no panacea, either (despite what some in this industry would have you believe).

Information about investing is also more available than ever. Today, the average investor can myopically watch stock futures tick on Sunday afternoon in anticipation of Monday morning’s open. (I don’t recommend this practice.) You can watch foreign markets’ gyrations at 2 AM. (Also not recommended.) Television channels are devoted to markets, telling stock stories the way brokers used to pitch them in cold calls—they ramp you up with excitement for live coverage from the bond trading pits! (I don’t recommend tuning in.) You can pay up for newsletters, read academic journals, analyze stocks online or buy into blogs (buyer beware). Opinions about where stocks will head are easy to come by. This stands in stark contrast to earlier decades when economic research meant a trip to the library. Today, the library comes to you on your screen or, assuming it’s a book you want, to your e-Reader or home in a package. But more isn’t synonymous with better. The information overload is to investors’ benefit and detriment simultaneously. After all, more information is a plus if it’s good information—but can be a minus if it’s not. Altogether too often, folks get hung up viewing information that is less than worthless. Not all information or information sources are of equal value.

A similar argument pertains to access—transparency via online account viewing, ease of online trading and more. To me, transparency is a positive force, a powerful protection against fraud and one that helps keep investors aware of markets and how they’re doing. Before, this information arrived monthly in a paper statement. Today, it’s there for you at a moment’s notice. Is that good? In my view, on balance, yes. But at the same time, it allows you to watch your account balance tick up and down on a moment-by-moment basis, stirring emotion. For many investors, this has led to big emotional reactions to short-term phenomena.

As Benjamin Graham put it, “The investor’s chief problem—and even his worst enemy—is likely to be himself.” And he wrote that before online access, cable financial news and the like! This may mean you need help. In the era before online brokerage was so prevalent, the buzzword was KYC—Know Your Client. Still is, to me! But can a website truly, actually know you? Does it have robo-values that involve putting your interests first? Can a website that simply provides information and takes orders be anything other than a yes-bot?

Democratizing Wall Street has simply leveled the playing field to a greater extent than ever before. What you do with that access is still up to you—and, perhaps, the quality of help you obtain. Mistakenly believing cheap means good, more information means better, and easier access spells success, doesn’t quite grasp what democratizing markets means. It means you are more free—more free to fail, too. While Oscar Wilde and I probably wouldn’t agree on much, I can see the sense in this famous quote: “Democracy is the bludgeoning of the people, for the people and by the people.”

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