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.