Should investors trust Wall Street, Main Street or University Street?
Reprinted courtesy of MarketWatch.com.
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Of the many choices investors must make, it’s hard to find one more important than where to turn for trustworthy information, advice and help.
This column, adapted from a chapter in my book “Financial Fitness Forever,” is the first in a series that will address the four most important choices every investor faces. The others involve how you diversify, how you control risk, and whether or not you will try to beat the market.
Investors who get even one of these four choices right will have a leg up on the competition. Nail all four of them (it’s not really that hard), and you’ll be among the most successful investors of your generation. I’ll finish the series with a fifth column in which I’ll tell you how to reduce your stress level while you make sure all these things get done properly.
Who to trust?
To start, we’ll look at a very fundamental choice. Get this one right, and most of the rest of investing will fall into place naturally. But if you get this one wrong, no matter what else you do you, you’ll be swimming upstream.
Here’s the issue: Where are you going to place your trust for information and guidance in investing? Many individuals and institutions claim to know what is best for us. They all want our trust, but not all of them are worthy of it.
In all my years in the investment business, I have found only three basic choices.
- You can trust Wall Street, which includes investment banks, insurance companies, brokerage houses, banks and mutual-fund families.
- You can trust what I call Main Street, meaning your neighbors, friends, relatives, colleagues, and people you may meet casually.
- You can trust the academic community, which I call University Street.
Who wants what?
For starters, let’s think about why each of these “streets” wants your trust.
Wall Street is made up of tens of thousands of people who want us to rely on them so they can make money from us. But despite all the smiling faces and carefully phrased inducements, Wall Street is riddled with conflicts of interest as well as hidden and undecipherable fees that nibble away at our assets every step of the way.
Main Street also has an agenda, but it’s less obvious. Our friends, neighbors, colleagues and relatives want us to respect them and understand how smart they are. The trouble is that they will rarely if ever show us proof of their claims about how well they have done. Did your braggadocio neighbor ever show you his annual trading statements or his tax returns? (No, I didn’t think so.) So, you have no way to judge the truth of what he’s telling you.
The third choice, University Street, has the most interesting agenda. Professors and graduate students don’t really care about us. Instead, they want to figure out the intricacies of investing so that their peers will realize how brilliant they are. They want their research to be published, with all the attendant opportunities that can result, including tenure, acclaim and even potentially the Nobel Prize.
Let’s look a bit more at each of these choices.
In my book, I paint quite a negative picture of Wall Street.
However, we investors need some version of Wall Street. What we need is a better Wall Street. We need a Wall Street that’s aligned with our interests. We are the ones whose money is at stake and whose futures are at stake.
If you have a broker, you probably like him or her. In fact, your broker is probably on your side. But I believe that the rest of Wall Street is essentially a deck that’s stacked against you.
Brokers face constant pressure not only to sell, but to sell high-profit products that entail high risks. Here’s an anecdote from my book: A friend of mine who is a broker told me his manager stopped by his cubicle one day to ask why he hadn’t sold his allotment of a new security the firm was pushing.
This broker, always direct and to the point, told the boss: “Because I think it’s [garbage]!” The manager replied: “You will either sell it to your clients, or you will buy it in your own account.”
Whether or not you ever realize it, if you put your faith in Wall Street, sooner or later you will run smack into a conflict of interest like that. And when the conflict is resolved, Wall Street will be the winner.
With Main Street, your worry is not about conflict of interest. Here, your worry is that you will likely never get the whole truth from a friend or relative.
Study after study has shown that most investors don’t even know exactly how their own portfolios have performed. We like to remember our gains, and we find it quite convenient to forget our losses. So can you really count on what your neighbor tells you?
I have a friend who, if I take him at his word, has never had a losing trade. With a record like that, he should be managing billions of dollars.
If you listen carefully to what you hear on Main Street, you’ll almost always find that the bragging is about short-term results, not those that span decades. Next time someone tells you about his great results, ask for an explanation of his long-term strategy and the assumptions that underlie it. I bet he will change the subject pretty quickly.
As you know by now, my choice is University Street. But here’s a very valid question: Who keeps the academics honest? Unlike Wall Street, professors aren’t regulated by the government, and they aren’t subject to the discipline of the marketplace. They don’t have much reason to care whether we scoff at them or admire them.
What they are concerned about is the opinion of their peers. Peer review is a process in which professors evaluate the work of their colleagues, maintain standards and try to protect credibility. Most academic papers are reviewed by experts in the subject matter before they are published. Papers that fall short may be critiqued in print or even denied publication.
This process isn’t perfect, but it strongly discourages authors from making statements they cannot back up. To my mind, this is a comforting source of credibility.
The full chapter in my book is titled “Where Will You Place Your Trust?” It contains a lot of good material that won’t fit in this article. I’ve made it very easy for you to get the whole chapter, which I have recorded as a 48-minute podcast.
Most of my writing, my podcasts, my public speaking and my discussions with individual investors are about how we can become more successful by applying the lessons of the academic community.
University Street is where I place my trust. I think you should do the same.
Richard Buck contributed to this article.