Investing vs. Las Vegas

Readers of The Investment Edge know that I sometimes compare investing and gambling. They’ll remember my theories about people who come back from Las Vegas making one of the following statements: “I won. Came out ahead,” or “It was good, I broke even,” or finally, “I only lost a little bit.” 

Of course, if those statements were true, Las Vegas wouldn’t exist. I’ve met only one or two people in my life who said something like: “Las Vegas cleaned my clock!” The last one was a semi-professional gambler more than 20 years ago.  

Investing

Many of us, unfortunately, treat investing like gambling. I can remember investing that way early in my career — picking one or two mutual funds or stocks, based on rumors of upswings (yes, we had rumors, even before the Internet), or because I had heard that the fund or company had a good reputation. At the time, I had no idea what a growth fund was, or a value fund either, and I couldn’t have told you if IBM stock was better than General Electric, or if airline stocks were any good. I’d never heard of the Dow Theory.1 Nonetheless, despite my lack of education and understanding, I thought I was as good as anyone at investing, and the NASD2 and the state of New York even licensed me as an investment professional. I was no more a student of the investment business than the average tourist in Las Vegas is a student of the gaming business. But I was licensed! I was a professional. 

Internships

Once we are licensed, we can inflict as much economic damage on a customer as an untrained surgeon can do physically to a patient. That’s why doctors have internships — so that they can practice the book knowledge they learned in medical school. Investment professionals, meanwhile, are supervised, but not in specific investment choices, other than through fairly loose “suitability” forms. 

Most investment professionals don’t get practical hands-on portfolio training. Even if there was a “portfolio school,” it would need to be run by people with real-world, successful portfolio experience. There are not many of these people, which is one of the reasons why portfolio engineering today, for most investment professionals, is general and theoretical — a dab of value, a soupcon of growth, heavy on the large-cap,  and two sprinkles of natural resources, please. As I’ve said before, newly minted investment professionals would benefit from serving an apprenticeship with a firm or an individual practitioner who has the requisite portfolio experience. What passes today for portfolio training is pitiful. Many of those who do portfolio work were taught in the same general way and do the same general things. In my view, some of their resulting portfolios are positioned for mediocre performance at best, and gut-wrenching, horrible results at worst. 

10/90

If you discount for investments in retirement plans, my estimate is that, over time, 10% of investors do well, and 90% do poorly, regardless of whether or not an investment professional is involved. I can’t quantify this at all; it’s just an estimate based on years of experience. (I think retirement plan investors do better — maybe 30% good and 70% bad — because people, including investment professionals, are less likely to fool around and change the investments as often). If I’m right, or close to right, it supports my thesis that most people perceive of investing as gambling, perhaps even sometimes as necessary gambling.3 

I’m certain a percentage of people make no more than 2 to 3% annually on their investments — less than CD rates. I include them in the 90% figure. 

If everything I’m saying is true, it is a terrifying realization, because investing need not be gambling at all. The problem is that, whether you’re a licensed professional or simply an interested investor, you can’t get good at portfolio work without either serving an apprenticeship, or through personal experience. The latter choice, for the professional, is likely to come at the expense of customers. For investors, the pain will be more localized.

I’m sure I hurt some investors while I learned the ropes. I was lucky in that my learning experience was incremental — there were only a handful of funds when I got my ticket, and not nearly as many quality stock choices. In those days, our training focused on planning and the investment parameters were narrow. Our choices initially were limited to a carefully selected group of mutual funds. This allowed us to observe and learn, but we still lacked experience and education; I am virtually certain that I unintentionally hurt investors during my learning curve.    

The Tragedy

I don’t want to be overly pessimistic. I just want to emphasize that it’s possible to be an investment (portfolio) expert and remove the subject of investing completely from any comparison to gambling. If portfolio work requires a certain kind of person, and you’re not it, you can still be an investment professional — all you need to do is turn the portfolio work over to an individual or firm that knows how to do the work. 

FINRA requires a Series 66 (or 65 and 63 combined) to be an investment advisor or advisor representative. You have to pass the test even if you only want to direct business to an outside firm or person (third party). (If I had the power to make the rules, I’d have an alternate test for advisor representatives so that they could use third-party portfolio experts without learning everything about advisory work, and still be paid ongoing referral fees; but alas, I don’t get to make the rules, and that may be a good thing anyway.)  

Here is a partial list of firms, in alphabetical order, that provide third-party investment advice:

• BTS Asset Management, Lexington, Mass.
• Clarke Lanzen Skalla Investment Firm, Omaha, Neb.
• Dunham and Associates Investment Counsel, San Diego, Calif.
• Portfolio Strategies, Inc., Tacoma, Wash.
• Morningstar Managed Portfolios, Chicago, Ill.

There are a number of other firms, like those listed, that will manage money inside an advisory account.  Usually, such accounts are located on a trading platform — Trust Company of America and Fiserv4 are popular, as is TD Ameritrade. Some of the firms I listed above will even manage a portfolio inside a variable annuity.

Typically, an advisor or advisor representative places his or her customer with one of the third-party firms, and receives an ongoing fee. It’s not unusual for an advisory firm to earn less than 0.5%, and for the referring advisor or advisor representative to earn a level 1% yearly. (I wrote not long ago about the advisor I met who has $1 billion under management; he actually personally manages nothing  — all the money is at third-party firms. His annual compensation is probably in excess of $10 million.)

So, if you don’t want to learn portfolio work — if you really get into it, the software expenses alone are significant — find a good third-party advisory firm and gather assets.  You’ll be well compensated in two ways — financially and by having happy customers.  

Broker’s Bookcase: The Book I Didn’t Want to Review

The Pirates of Manhattan — Systematically Plundering the American Consumer & How to Protect Against It, by Barry James Dyke (555 Publishing, Portsmouth, N.H). Barry Dyke is a smart fellow. There’s a lot to like about his book. But I have two problems. First, I normally only review books that I don’t have problems with — life is short; why review books that may not work for my readership? All I do is annoy a writer. Instead, I try to find books that will help my readers, and ignore ones that might not.

The other problem is that some of Dyke’s writing and ideas are damn good and others are, in my view, doggone bad. So, dear reader, this time I’ll let you decide. 

Consider the title of the book. I would have preferred something a little more direct, such as The Pirates of Manhattan — How to Keep Your Ship Afloat During the Systematic Plundering of the American Consumer, or something like that. 

Dyke has some interesting thoughts about Solomon Huebner’s human life value concept and compares it with the methodology used to pay death benefits to the families of the victims who died in the Sept. 11th terrorist attacks. (Out here in Oklahoma, we still wonder why life is expensive in Manhattan and cheap in Oklahoma City, because families of the 1995 Oklahoma City bombing victims got little or nothing, while the 9/11 beneficiaries got an average of about $1.8 million apiece.)  

“Never Met a Man Who Made His Millions in Mutual Funds” is one of the chapter headings (the chapter breaks are not always easy to identify, by the way). I’m not sure what “made his millions” means. Most people “make” money by working for it, investing it, inheriting it, or by winning it. As one earns, inherits, or wins money, the important question is whether he or she will be a good steward of it. People do “make” millions of dollars by using mutual funds and other investments. Some even make a million or so simply by reading a newspaper each week. Here is part of a letter to the editor published in Barron’s in January 2007:

The Feeling Is Mutual

To the Editor:

I have been a subscriber for a dozen years or so, and I would like to provide my feedback to you and your staff.

You guys have made me rich. Through reading Barron’s week in and week out, I learned a great deal about finance and saw how normal it is to save, make decisions about my own investments and be informed about financial matters. I have never drawn an annual salary exceeding $50,000, yet I am a millionaire.

Your articles outline successful investments and expose fraud. Unfortunately, there are as many bad ways to invest as there are good ways. Barron’s presents the wealth-building strategies of adults.

You also provide information applicable to various wealth levels. Naturally, you offer information for the ultra-wealthy, which — although interesting — is of little use to me. But the majority of the investments you discuss really only differ in the number of zeroes on the end.

I find your articles quoted elsewhere. Adults respect the journalistic integrity of your work, and that speaks volumes.

Your staff seems upbeat. They are not perma-bulls, but they are optimistic about the prospects that each day brings. They write to the readers as their peers, rarely referring them to a broker for help. ‘You are a Barron’s reader, if this appeals to you, then go do it,’ is the tacit tone.

I know what I am getting when I read Barron’s, and I like the feeling…

Do I believe that a person can make $1 million or more simply by studying Barron’s, and sagaciously applying the information learned? Yes, absolutely.

Enough carping. There’s lots of good in Pirates. I would have liked more citations; even so I’ll accept that the author is probably right when he asserts that General Motors “assumes a high return of about 10% on investments in its pension portfolio. Yet in 2001, GM actually lost 5.6%.” The author makes good points about how long it takes to recover from such downturns.

And I accept that Janus Investments made good money it its heyday, and that it was guilty of major, major wrongdoing. And it was not alone.

Dyke has a sharp eye for skullduggery. Consider this: “With the repeal of the Glass-Steagall Act, the banks and securities businesses regained control of all the power they lost in the 1930s … From 1933 to 1999, that act served this country well. In the 1930s, Congress had found that the practice of tying commercial loans to shaky companies to gain follow-on stock and bond offerings was a major contributor to the … over-speculation … in the 1920s, which ultimately led to the Crash of 1929 and the Great Depression.”  

I agree with Dyke’s assessment of banking and Glass-Steagall; I believe there is sound reasoning for separating commercial and investment banking. Investment banking — think about the sub-prime mortgage mess, which I discussed in last month’s column — has done nothing to prove that it can or should be trusted. 

This is unquestionably a worthwhile read, and I “get” Dyke’s point of view, it’s just that I don’t always agree with it. After all, I’m an investment guy, and my customers and I do make money with mutual funds, stocks, and bonds. Nonetheless, Dyke writes well and has an interesting mind and a good sense of humor. You may order a copy by phoning (800) 335-5013. Be sure to check out the name of the pirate ship on the cover — it’s the HMS Deregulation. 

Footnotes

1. The Dow Theory is based on capturing major market moves in a stock or group of stocks. It is a way of discounting overall market “noise” in favor of concentration and uses the Dow transportation index as a comparative — when it’s on the rise, it may mean that things are humming along nicely in the business world.

2. Now the Financial Industry Regulatory Authority (FINRA).

3. In this case, “necessary” means hard to avoid — people have to pay at least some attention to their qualified retirement plan assets, whether they want to or not.

4. Purchased by TD Ameritrade in the spring of 2007; the combining is still in progress. 

• 8 tips to help you seize the LIAM marketing opportunity
• Develop the mindset of a champion in your insurance career
• Life insurance coverage hits a 50-year low, but there is a silver lining
• Allstate introduces new life insurance product
• Sliced, with taxes on top
• Penn Mutual’s Thomas Harris appointed to The American College’s Board of Trustees
• Ninety percent of mortgage holders pay on time