Wall Street's boiler roomArticle added by Brian Schreiner on May 22, 2009
Ranked: #1864 (92 pts)
In the 2000 movie Boiler Room, Giovanni Ribisi, Ben Affleck and Vin Diesel play cocky young stockbrokers engaged in a lucrative, albeit fraudulent, sales gig. Their firm, J.T. Marlin, is a chop shop, running a "pump and dump" scam. After creating artificial demand in the stock of defunct companies and, in turn, generating huge profits for the firm, their clients are left holding the bag when market liquidity dries up and the stock price plummets.
We know all too well that scams on Wall Street still exist. Con artists, swindlers and sharks are not born on Wall Street; they are attracted by the potential rewards offered by transactions in high finance.
For every fraudulent act committed on Wall Street, there are many less than fraudulent actions that can have similar consequences for investors. Oftentimes, these less than fraudulent, but still potentially harmful actions are carried out by professionals who do not fully understand the real risks of investing.
Case in point: Investment advisors selling a buy-and-hold approach to investing. It's not fraudulent, but the consequences of failure can be catastrophic.
The perfect business model
If you were given the task of creating the perfect business model for Wall Street, what would you design? Actually, you wouldn't have to design anything -- they already have the perfect business model. At its core is an investment strategy (buy-and-hold) that commands investors to hold their products forever.
According to their model, investors should consider any downside volatility as temporary -- a short-term bump in the road. They tell investors that the market's historical average returns will be achieved in the future, as long as they will just be patient and wait. Investors are told to ignore any "paper losses" in their accounts, regardless of how big they are. If you just hold on, the model says, the returns you want are just down the road.
In Wall Street's perfect business model, the advisor can never be wrong -- only the investor can be wrong. "Remember, you're invested for the long-term," is the answer to every client's question. It's the solution to every client's concern and the remedy for every client's fear. "You can't sell now," they say, "or you'd be locking in your losses. Remember, you're a long-term investor."
Buy-and-hold is the perfect sales pitch for targeting the masses because it's easy for unsophisticated investors to understand. Armies of salespeople can deliver with ease because it requires no special training or any true understanding of the investment markets. The way I see it, selling a buy-and-hold portfolio is not much different than selling a used car -- at least if you crash the car, it won't cost you half of your life savings.
Having the perfect sales pitch is important, but there are other key pieces to Wall Street's perfect business model: The support of professional organizations, academia and the greatest bull market in history.
The passive buy-and-hold style of investing continues to be supported by powerful organizations that offer professional designations such as CFA® (chartered financial analyst) and CFP® (certified financial planner). In addition, thousands of colleges and universities continue to teach investment theories that were developed in the 50s and 60s.
I believe that these theories, including Modern Portfolio Theory and its supporting theories, the Capital Asset Pricing Model and the Efficient Market Hypothesis, are based on incorrect assumptions that underestimate risk and have unrealistic expectations for returns. They incorrectly conclude that investors are rational, return expectations are constant and that risk premiums are stable. Today's market research and real-life experience proves that these old theories have holes -- big ones.
Wall Street executives are not stupid; they know these theories are flawed. So, why do they continue to promote them? Why keep selling buy-and-hold?
After all, why would they give up on a business plan that has generated such tremendous profits and can be implemented with so little effort and expense? It must be said, however, there are a growing number of advisors who are moving toward active management. That's not surprising, seeing what happened in the last decade.
Despite this, the vast majority of advisors haven't budged; they still preach buy-and-hold. No major investment house has wavered -- they are all saying that 2008 was just another bump in the road.
Investing is a two-step process
Any way you slice it, successful investing is achieved through basic two-step process: buy low, then sell high. Unfortunately, buy-and-hold investors only "buy." They are exactly the kind of customer Wall Street likes.
Markets are constantly changing -- creating opportunities for investors to profit using the "buy low, sell high" concept. Despite what you hear from the media and the advice you get from many investment professionals, successful investing isn't just about making a single decision to buy stocks and accumulate shares.
Successful investors have a process for extracting profits from the markets. They take a proactive approach to investing -- they have a plan for both strong markets and poor markets.
Our process uses current and historical market data and mathematical formulas, which we apply to markets on a daily basis. The buy and sell decisions are objective and rules-based. They are specifically designed to avoid emotional decision-making. Our processes are mechanical -- based on risk analysis and probabilities. The goal of all of our investment strategies is to minimize risk and take advantage of opportunities in the markets.
Questions for your advisor
If your advisor believes in buy-and-hold, hope and rebalancing is the backbone of his investment process, what is his plan for bear markets? How will he manage your portfolio if this recession continues, God forbid, for another five or 10 years?
If you're not sure, take a look at your account statements for the last five or six quarters. What service did your investment advisor provide during the crash last year? What did he do to protect your assets?
Good intentions and positive expectations can only take you so far. Without a sound investment process, it's unlikely that you will be able to reach your retirement goals. If the lack of a real investment plan caused you big losses last year, does it make sense to compound the mistakes by continuing with a "buy-and-hope" approach to investing?
It would be great if investing were as easy as "buy-and-hold," but the real world requires us to work harder than that. Successful investors do not make money by sitting on their hands. They make many important decisions about when to buy and sell.
Successful investing is not a one-decision process, it never has been. Sitting back and doing nothing while markets crater is not a legitimate investment plan -- it's a wish. If your advisor is not doing something to earn his management fee, it might be time for you to move on. It is too late to do anything about the past, but you can certainly do something about your future. Investing is a life-long journey.
*Author's Note: Brian Schreiner is Vice President of Schreiner Capital Management, Inc. ("SCM"), a federally registered investment advisor located in Exton, Pennsylvania. SCM is focused on protecting and growing their clients' assets through unique investment strategies aimed at succeeding in both up and down markets. SCM takes an active, disciplined approach to investing, which recognizes and reacts to current market conditions. To learn more about SCM, visit www.scminvest.com.
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