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Blogs - The Advisors' Coach
Main Street vs. Wall Street: Why Investing Is Not Speculating
Wednesday, August 22, 2012
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I was recently talking with an experienced advisor about many investors' inability to comprehend capital markets. The advisor said that the majority of the people he deals with are concerned that the financial system is rigged against them - constructed by policy makers, regulators, banks, rating agencies and Wall Street firms for their own benefit.

"Clients feel sometimes as if they are playing in a casino, where the house always wins," the Advisor said. "How do I help them understand the difference between Wall Street and what I do?"

This question made me reflect on how poorly served we are by Wall Street as a whole, as well as the financial media. All the hype and noise and product pushing serve only to obscure some very simple and powerful truths.

Most stock exchanges, such as the NYSE or NASDAQ, are owned by seat members. The revenues those seat members generate are primarily driven by the trading on their exchange. Therefore, they encourage trading. Vulnerabilities occur when someone feels that someone else may have an upper hand. And I would argue that most clients should feel vulnerable. After all, their interests are not aligned with members of the exchange. That's where lack of trust occurs.

Now, investing in companies is different. Investing in companies means you are giving capital to a company, and they use that capital for research or to expand their product line, streamline their processes, etc. to generate higher earnings. In exchange, the stock holder will participate in a share of the future earning potential which, if all goes well, will be bigger than today.

The return the investor should expect is equal to the company's cost of capital - the riskier the company's future earnings, the higher their cost of capital. If clients BUY all publicly traded companies and HOLD them, then they can get the return on their initial investment equal to the collective group's cost of capital. Therefore, they are investing in people, entrepreneurship, new inventions, new industries, more efficiencies ... in other words, the future.

Investors shouldn't need to worry about the system being rigged against them. True investing is not gambling - the odds aren't fixed against winning. Imagine if the client had the option of giving their gambling money to buy a stake of the casino's profits. Would you expect the casino to keep more than all the players? If so, you understand investing.

Anyone who believes that the human race will not continue to become more efficient and create transformative inventions probably should not invest in companies. The rest of us should continue to invest prudently, broadly and for the long term.

______________________

Steve Atkinson, CFS, is Executive Vice President of Loring Ward, Head of Advisor Relations, providing support and coaching to help advisors grow their businesses.

(1) Comment
Mr. Atkinson: I respectfully disagree with most of the points you make in this article. The New York Stock Exchange is owned by its shareholders, many but not all of whom were at one time, seat holders. It exists as one of the many places that shares can be bought and sold. But the advisor you speak of was much more accurate than you in terms of the environment on the markets today. When you consider high speed trading and computer algorithms that are written to rapidly take advantage of slight price discrepancies that occur across multiple markets, even institutional money managers are at a disadvantage. And the exchanges don't exist for the deployment of capital from investors. The majority of trading on all exchanges is between existing shareholders. The companies received the proceeds of their offerings years before. When I buy IBM shares, IBM doesn't see a nickel. I will concede to you that properly researched equity investing can produce highly attractive results over the long term. But to say the return will equal "the collective group's cost of capital" ignore the significant reality of the inefficiencies of today market and is disingenuous at best.
Posted by Stephen L | Thursday, August 23 2012 at 9:56AM ET
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