Are We Suckers to Invest in the Stock Market?

"Does Blue Horseshoe really Love Blue Star?"

There is a lot of hype going on about Facebook’s anticipated Initial Public Offering set to take place in Spring 2012. Really. You hear it all over the place, how Facebook’s IPO is going to make a lot of people rich.

Well, guess what? Those lots of people are not you and I, they are the Investment Bankers that will put the IPO together and get a percentage of the sales. They are the Investment Institution that will buy thousands of shares and then later sell them in the secondary market. They are the people who work for Facebook and who are entitled to some sort of profit-sharing via stock shares.

You and I, we’d be lucky if we can catch the shares at a low cost before the market hype spends the shares into a over-priced chaos. I can dogmatically say this because even if Facebook takes off at the same trend as Google, one would have to hold the their shares for at least three years and then sell them at “the right time” to collect on the seven fold increase in their investment.

According to Morningstar’s Chart of Google, their IPO was sold in the open market at around $108 in August 2004, and reached its peak of around $711 in November 2007. The “little” guy, if was lucky enough to invest $10,000 to catch a hold of Google’s shares at $108 and timed the market to its peak, still wouldn’t be strikingly rich. Yeah, a 700% gain is impressive, but still not enough to pay in full a $100,000 home mortgage.

This 700% theoretical gain for the lucky guy doesn’t even take into account the aspect of Behavior Investing, that, in summary, says that the little guy reacts too quickly to dips in the market or negative news. For example, Google had several dips after its IPO before it hit $466 in January 2006. Then, for whatever reason, it hit $337 in March 2006. Believe it or not, I would have most likely freaked out,  sold at a 300% gain, and walked off happy. But then I would have been screwed, right? Because from hindsight we know that Google later shot to $711 almost two years later.

All the while, guess who was making big money on these sales? Yep, the Institutional Investors and the “professionals” who were taking a percentage of all the sales, trades, and buys.

Again, let’s focus on Facebook. Much like Netflix shocked the hell out of its investors by introducing what seemed like an impromptu price change and structure this past summer, Facebook, too, is always changing something in their software that seems to piss off their users (temporarily), or seems to be under some sort of legal investigation for privacy issues. If you don’t know, Netflix share’s went from trading at about $239 per share earlier this summer to now roughly $70 per share to date? What says that some poor sucker won’t get caught in Facebook’s future debacles and lose 200% of their investment? Nothing. Absolutely nothing will protect the “little guy.” We can scream out ”diversify, diversify, diversify” all we want, but a 200% loss is still a 200% loss.

Reflecting on “The Markets” in General

First, like I wrote in my book, How We Prevent Wealth: A Personal Finance Reflection, we are horrible investors. I know I am. With so many different types of ways to invest, and then so many underlying investments in each way to invest, there is no certainty of riches for the little guy by simple investing techniques. Some people scream that ETFs are the way to go, while others scream Mutual Funds. Then there is the fight for active vs. non-active funds. No one can say for certain that one way to invest is better than another. And then, there’s a”fund eat fund” market out there.

There is no secret why Investment Institutions take their expenses from their funds and advertise on nationalized cable networks to inform us, “the little guys” that we should invest with them. Sure, we should go with the Institutional Investment Firm that  advertises the “lowest” expenses for their funds, but while we think we are winning by doing this, the Institutional Investment Firm wins either way. “Oh, the market tanked? Guess what, we’ll still be charging you those fees that makes up the expense ratio for those funds” or ”Oh, the market did well, good for you, but we’ll still charge you the fees that makes up the expense ratio for those funds.”

How Much have you Gained over Your Basis?

I know for one thing, I’m pretty conservative when it comes to investing. I’ve been investing in my retirement account since 2003. I invest in low cost, life cycle, index funds. But guess where I’m at? I’m up only 1.08% of my cost basis, or the money that I’ve contributed. In other words, if you were investing in what I’ve invested in, a $10,000 initial investment would only be up by $108 over a 9 year period. This is money that has been tied up in an investment account that hasn’t been used for anything else. So, the opportunity cost of “investing for retirement” for my 1.08% gain, is the loss of money that could have been used to pay down a mortgage that is at a 6.5% interest rate.

A Possible New Approach to Investing?

I get it. I even wrote about it in my book–that we need to understand the importance of retirement savings. I also wrote about the importance of setting purposeful, measurable, and realistic long terms goals that may include saving for our kid’s college, planning a trip, or buying a car. But if we think about it, all of these goals can be met without taking on the risk, and “payout” of the markets.

Think about it.

Here is a great example:

If you simply put away $1458.33 monthly into a ”measly” 1.08% annual rate of return, online savings account instead of a 401(k) every year for 30 years time, one would have approximately $620,000 at the time of their retirement, not taking into account inflation. BUT, if this same money was put away in, say, extremely low risk municipal bonds or treasuries, which averages 4% annually AND helps out the economy, one would have approximately $1,025,642.77 in that same 30 years. Try the numbers yourself using Bankrate’s simple savings calculator.

If one uses the true measure of effectiveness for their retirement savings, namely the income stream that it will bring, then this $1 Million can provide a $50,000 annual income for at least 20 years. If other financial obligations have been taken care of such as the home mortgage, cars, and children’s education, you undoubtedly be wealthy.

Conclusion

I just think that there is a lot of hype to investing in the markets, and the big winners are not the “little guys.” Maybe I just need to educate myself a little more on what it has done for other people. Has the ”Markets” really made them rich? I mean, can you, a person with probably only $1000 a month to invest, really afford to take on the risk of return even if you get a 3% matching contribution? Even still, can you afford to have your money locked into a fund and then taxed and penalized if you need to pull the money out because some debacle in the housing market forces you to sell your home at a loss?  I don’t think so. I’d gladly love to be proven wrong. Unfortunately, the small guys that were vested into the 21 Famous Corporate Bankruptcies  would probably agree with me.

So,  until you know what you are doing, which means knowing what investing in by understanding financial statements, or prospectuses, you should refrain from being a sucker, or in other words a speculator that is just “hoping for the best” but meanwhile paying out plenty in opportunity costs. The alternative is to master the basics of personal finance–pay off a home, minimize the use of credit, and live within your means–and use the risk free $1 Million to live on in retirement. I’m sure you’ll sleep easier because you won’t have to worry about the market fluctuations that you don’t even understand.