Rule number one for spending your hard-earned dollars—pay for value. This rule is so obvious that it’s almost offensive to mention. When you plop you body down at a Motel 6 for a quick sleep while on the road, you don’t expect to get the Ritz Carlton. And few will complain of spending top dollar for an unforgettable dream vacation spent celebrating one of life’s precious milestones with the ones you love. You work hard for your money and when you spend it, you want value commensurate with cost.

Yet in a macabre twist, millions of retirement investors line up ever day and pay Wall Street to take their money. As ridiculous as this sounds, the facts overwhelmingly and conclusively demonstrate that actively managed money significantly underperforms passive investing over time.

The perfect business model

To put this in context, think for a moment about how corporate boardrooms as well as Silicon Valley start-ups are filled with the same vigorous discussion: how to offer products and services of value to customers that will result in increased market share and profits. While real companies compete to improve their goods and services, the financial industry has pulled the ultimate business coup: They have discovered the perfect business model in which people pay for them to simply take their money. Sound absurd? Take a look at the facts.

In Rick Ferri’s recent book, The Power of Passive Investing, the ineffectiveness of active money management is reviewed going back as far as 1930. As Ferri points out, Nobel Prize winning economists of the likes of William Sharpe of Stanford University and Jack Treynor of MIT; leading researchers like Eugene Fama, Harry Markowitz of the University of Chicago, and Burton Malkiel of Princeton; and the popular writings of John Bogle and many others have all demonstrated that after expenses, active management is a fool’s bet. A study by S&P showed that over a five-year period, nine out of nine equity fund categories underperformed their corresponding passive indexes.

Why does active money management underperform, you may ask? The reason is quite simple: It costs too much. Most active fund managers have to beat their benchmark index by 1-2 percentage points each year just to break even on an after-expense basis. A performance improvement of 2 percent may sound small. But when we remember that the total stock market’s long-term return is only 8-10 percent, it starts to become clear why so few funds are able to perform such a feat over any extended period.

And for some investors, the bad news does not stop here. For instance, investors may turn to advisers who, according to a recent study, charge an average of 1.1 percent annually for further disservice. The net can be devastating. A 2.5 percent fee drag over 20 years can mean retiring with as much as 40 percent less compared to an investor who stayed the course with a passive portfolio. And don’t count on trying to have an honest discussion with your adviser about these facts. As John Bogle, the founder of Vanguard, once said, “It is amazing how difficult it is for a man to understand something when he is paid a small fortune to not understand it.”

How to be the 1 percent

Here is another shocking fact: A study performed by DALBAR, Inc. compared the average investor’s returns with the returns of the S&P 500. Investor returns are quite different from the index’s returns. Why? Because investors, often at the behest of their advisers, buy and sell funds due to such things as market swings or the never-ending search for the next, hottest five-star fund. The study looked at the S&P 500 from 1987 through 2007 and found an annualized return of 11.81 percent. The average inventor’s annualized return for the same period was a shocking 4.48 percent, more than a 7 percentage point difference, or what has been described as the behavior gap.

The problem of active money management is a multifaceted nightmare: money moving in and out of funds, unnecessary and unwanted tax friction, and fees upon fees. Why does any sane investor sign up for such abuse? Those in the know continue to wonder.

Possibly the cause is rooted in the astute advertisements run during the Masters, British Open, U.S. Open, and beyond that get your investment account open and your mind closed. Critical thinking skills can be whisked away by multi-million dollar marketing campaigns targeted to cast their spell. Once an investor buys the commercial rhetoric, a hypnotic trust can hijack critical thought. The hypnotizer can get the otherwise astute subject to perform the most ridiculous behavior, such as paying someone to take his money.

The only hope for the hypnotized investor is that actual facts will provide a benevolent snap of the fingers, awaking the subject to investment realities. By buying and rebalancing a diversified indexed portfolio over decades, you can escape the active management madness, leave the behavior gap behind, and find yourself in the top 1 percent of investment returns. In the end, paying yourself is much better than paying others for nothing.

Any while many investors had previously never heard of MF Global, the firm’s failure led to an approximately 10 percent single-day hit to financial stocks. A better understanding of the MF Global debacle may help you exorcise the goblins that may be lurking in your investments.

Indecent exposure

Apart from the alleged $700 million in missing money and illegal activity, MF Global’s core investment problem was its gun-slinging investment approach towards the sovereign debt of Portugal, Ireland, Italy, Greece, and Spain (better known as PIIGS).

Upon filing for Chapter 11 bankruptcy Monday, margin calls of some $6.3 billion in Eurozone debt was revealed. That’s five times the size of MF Global’s equity. MF Global placed a very large bet on PIIGS and in the end, it got stuck in the mud. Ironically, MF Global’s homepage mission statement reads: “Working relentlessly to bring our clients superior market access, hardworking insights and powerful trading and hedging solutions.” If accusations of wrongdoing prove true, they apparently left out: illegal use of funds, shortcuts, and daredevil investing. Powerful indeed!

Just when you begin to feel a bit of relief that your retirement dollars aren’t with that firm, a bit of research reveals that U.S. bank exposure to PIIGS and Eurozone debt is substantial. According to a recent report by the Congressional Research Service, nearly 5 percent of total U.S. banking assets are in PIIGS. That may mean your institution is silently at risk as well. Add to the sobering $641 billion in PIIGS exposure by U.S. banks $1.2 trillion in exposure to German and French banks and you are left with significant risks to U.S. banking infrastructure in the event that the Eurozone goes caput.

This brings us back to our investment primer—be a hawk at diversifying assets and managing risk. Warren Buffett’s famous maxim for investing is simple: “Rule One: Never Lose Money. Rule Two: Never Forget Rule One.” In the case of MF Global, rule number one was long forgotten in favor of leaning dangerously out to grab the brass ring. How does your investment portfolio look when it comes to risk management? Do you have global exposure to six or seven asset classes, or are your investments all stuffed into one asset class in a reach for high returns?

Will the big bad wolf blow your house down?

Worse yet, initial statements seem to indicate that MF Global had more than poor asset allocation to worry about. According to a board member at the Greenwich, Connecticut, firm Interactive Brokers, there appears to be at least $700 million missing from client accounts. Interactive Brokers was pursing a possible acquisition of MF Global when the alleged wrongdoing emerged.

Broker-dealers are charged with keeping client funds separate from company dollars, but according to testimony, MF Global used client money unbeknownst to clients for its own internal investing. How can an investor know if his broker is behaving similarly? The obvious answer is one can’t. Surely, however, placing funds under the care of one of the leading discount brokers that is less inclined to get involved in more esoteric investment banking activities is a start.

How safe is my money?

Moody’s downgraded MF Global last week. This downgrade was met by MF Global’s CEO publically minimizing the rating adjustment. In fact, while MF Global was swirling the toilet, its marketing arm was simultaneously sending out letters to clients reassuring them of the firm’s strength. Once calamity struck, clients who called MF Global on Monday were met with nothing more than a voice recording.

When a similar catastrophe strikes your broker, how do you know your money is protected? Investors may be aware of the Securities Investors Protection Corporation, a government-created entity which provides account insurance and oversees liquidation proceedings. Not all accounts have SIPC protection, so the matter of first importance is to confirm that your account is covered.

If your dollars are in fact covered by SIPC, you must understand the SIPC is not a guarantee that you will receive all lost funds. Unlike the secure promise of FDIC bank account insurance, SIPC coverage must be applied for within a designated deadline and may not cover all forms of fraud. It is the responsibility of the investor to provide the appropriate proof of assets and documentation with his application.

Kevin Bell from SIPC was asked about the process. “What customers ask is, ‘When am I getting my money?’” said Mr. Bell. “You tell them to sit tight, and start gathering their information so they can file claims.”

Some investors thought they had their money securely tucked away in a credible investment house. This week they awoke to their own nightmare to discover that their money was locked away in a house of horrors. Take some time to do a bit of research and vet your broker. Find out what their PIIGS exposure actually is. See if they in fact have high ratings from the ratings agencies. And keep a copy of your records close at hand.

If only life worked so charmingly. But in the cold world of Wall Street, the dumb are preyed upon, while the dumber quickly become extinct. Not only is this true, it is actually celebrated as fact by financial mavens and the media alike who have captured this ethos through their invention of the terms smart and dumb money.

In closed-door discussions from the venture capital industry, through the hedge fund industry, past leveraged buy outs and all the way to traders of simple stocks and bonds, those in the know whimsically discuss what the smart money is doing to get rich, and of course, how the dumb money is helping them get there.

And in the event that you are late to the conversation, in their mind at least, you may be the dumb money. More specifically, the dumb money is the individual investor who watches CNBC for stock tips. It is the investor that gets a hunch, or better yet, at stock tip from a friend and acts upon it. The dumb money is the lemming like masses that plunge off the bluff and into the sea when despair is on tap, and double down on their investment when a sector is running hot.

Like the ocean tides that move in and out with shocking continuity, the pros believe the dumb money to be so predictable, that these hawks consider it a contrary indicator of what the markets are about to do. When the dumb money is rushing madly into gold, the smart money starts writing shorts. When the dumb money is sure that the S&P 500 is dog meat and is running for the door, the smart money grins and starts moving in.

Fear, Greed and the Dumb Cycle

Dumb investors get caught in a dumb cycle—buying high and selling low. As ridiculous as this behavior sounds, a closer look reveals how the strong emotions of fear and greed can drive even the most determined investor towards this sadly dim-witted behavior.

In any intellectual exercise, like a crossword puzzle, knowledge wins. But in the real world, behavioral scientists have demonstrated that a primal need for rewards and security give tremendous platform to the emotions of both fear and greed.

To understand the dumb cycle, you simply need to understand the role of fear and greed in driving investment decisions. When an investment is returning nicely, the greed gland kicks into overdrive commanding us to buy more of what is working. The investor then sells his poorly performing asset classes and buys more of his winning investment. Likewise, when all hell breaks loose, the fear gland begins to repetitiously squawk like a malfunctioning fire alarm within the investor’s mind. Sell, sell, sell is it commanding instructions. Run for the door.

A simple analysis of inflows and outflows of capital to and from the mutual fund industry easily illustrates this point. In 2000, the dot-com hysteria had people so frothy that they were dipping into their home equity lines to double down on the new gold rush. The NASDAQ ran up to 5,000 and had a one-year return of a shocking 80%. The greed gland was pumping out its buy commands and the masses were moving in perfect harmony. Then, by the fall of 2002, the NASDAQ party came to a crashing halt, plummeting quickly to half it value. Fear was the order of the day and as money rushed out of tech, it moved quickly into bonds that predictably were at a record high. The dumb cycle was complete.

You Don’t Have to Be Dumb

Although Wall Street might look at you as the dumb money, you can in fact become the smartest money of all. To overthrow fear and greed’s reign of terror, the smart investor must develop principles and policies that will usurp the primal impulses that otherwise lead inevitably to the investment funny farm.

By rooting your portfolio management in highly researched and scientifically demonstrated principles of global asset allocation, disciplined rebalancing and especially staying the course when others are loosing their cool, you become a member of the smart money club.

In seasons of wild market swings, investing takes faith—faith that stocks will do better than bonds, and that bonds will do better than cash, just like they always have. It requires faith that via diversified participation in the global free market, you will benefit from the rigors of millions of workers and thousands of companies striving daily to do well.

While Dumb and Dumber provides a great laugh on the sliver screen, being the smart money provides the best laugh of all.

If so, consult your favorite Wall Street broker, mutual fund, or become a stock picker yourself. Either way, within 20 years, say goodbye to 33 percent of your money and many of those dreams.

How could this be true? Most people confuse investing with gambling. Gamblers try to “beat the house.” Investors want to be “the house.” Imagine a casino in Las Vegas called World Markets Casino. World Markets offers all kinds of gaming options—blackjack, poker, roulette, craps, slots—along with great food, entertainment, and well-appointed rooms.

Guests have a lot of fun at World Markets—the excitement of gambling, the thrill of winning and losing. Some come in with various “systems” like statistical models and card counting systems to beat World Markets. Others talk to God. Poker players have their favorite seat.

There was a Grandma who dropped a quarter in a slot machine and won $250,000. Another person who had never played blackjack hit 21 in his first hand, made $50,000, and proposed and married his girlfriend all in one great evening.

It’s fun being at World Markets—just look at the posters and marketing brochures.

But most guests don’t just play, win, and leave. They continue playing and that’s what World Markets counts on. Like all casinos, it has special “house” odds. Sooner or later World Markets will win more money than it will lose due to human nature and statistics. Depending on the game and how wagers are placed, the casino earns up to a 35 percent commission from the winnings. It is impossible to do consistently, but guests come year after year to try to beat the house.

Suppose you buy stock and invest in the imaginary World Markets, Inc. (WMKTS). Investors care about one thing only: making money. They’re not concerned with having fun or discussing the night they had the “hot dice” at the craps table. They could care less if they ever hear the noise of a winning pull at a slot machine. They just want to know that they’ll make money year after year after year.

World Markets investors never know from night to night where they’ll make money. Some nights there’s a guest with a streak of luck on the craps table and the casino loses money there. But that same night, perhaps World Markets is making money on blackjack. On nights where guests are beating the house on all tables, the casino is still picking up antes from the poker tables, and making money on food, hotel rooms, and entertainment.

World Markets investors are “the house,” and ultimately those investors always make more money investing in the house than its guests who are trying to beat the house. It’s just a statistical fact.

But how is it that most people invest their own money as if they were gamblers at World Markets, instead of investors?

Most investors attempt to “beat the house” of world asset markets—U.S stocks, bonds, real estate, foreign stocks, emerging market stocks—by picking stocks on their own, giving their money to a broker who they believe is a good “stock picker,” or investing in a mutual fund that has a great track record.

But reams of studies from experts have confirmed that investors do worse than the house by the money they spend trying to beat it. Investors leave an average of 2 percent of their money every year at World Markets and pay more taxes because buying and selling stocks creates taxable income. Over time, due to mathematical laws such as compound returns, investors can lose 33 percent of their money over 20 years—just like a guest at World Markets Casino.

So how do you become an investor in World Markets instead of a gambler? Buy and hold a collection of exchange-traded funds (ETFs).

For every $100,000 invested, you’ll pay $200 in yearly fees, instead of $2,000 in fees to money managers, financial advisers, and broker commissions. You can invest like smart investors and endowments at Yale, Harvard, Princeton, and Stanford. You’ll never have to pick a stock or mutual fund again. And you can dial the risk levels of your portfolio up or down to whatever level you feel comfortable.

Be the house, not the guest.

You’ve probably never heard of Phyllis Borzi. She is an assistant secretary at the Department of Labor and she’s helping you and our country in ways few will ever appreciate.

We’ve written extensively about the inherent conflicts of interest when you trust someone with your money. In finance circles, it is called “agency risk.” Yes, your broker, or mutual fund manager may not fully put your interests ahead of their own. These conflicts almost define how the investment management business operates and is regulated.

Borzi runs the Employee Benefits Security Administration (EBSA), which “pursues policies that encourage retirement savings and that promote retirement security for all working Americans.” Our retirement security depends in large measure on the sound investment of more than $11.2 trillion in pensions, 401(k) accounts, and IRAs. To guide our decisions, we get advice from trusted experts.

But a flawed 35-year-old rule gives brokers a loophole that allows them to skirt these fiduciary standards. Under her stewardship, the Department of Labor has been pushing through regulations that would force service providers to disclose fees and limit conflicts of interest.

“The law on its face is simple enough: advisers should put their clients’ interests first. But as always the devil is in the details – in this case, in the question of what constitutes paid investment advice,” Borzi said last week before a House committee. “(We) will amend a flawed 35- year-old rule under which advice about investments is not considered to be “investment advice” merely because, for example, the advice was only given once, or because the adviser disavows any understanding that the advice would serve as a primary basis for the investment decision.”

When it comes to your retirement savings, fiduciaries who advise you have a duty of “undivided loyalty” to your interests, to act prudently when giving advice. You can sue a fiduciary personally for any losses arising from breaches of such duties.

But the 1975 laws were made before 401(k)s and at the inception of IRAs. The loopholes and technicalities let brokers easily dodge fiduciary status. Borzi has reams of evidence showing that because of this, IRAs are dramatically underperforming 401(k)s.

“For additional evidence, consider the underperformance of IRAs relative to plans, the size of the gap is troubling,” Borzi said. “IRA holders do not have the benefit of an employer to represent their interests in dealing with advisers. From 1998 to 2007, the average annual returns for IRAs were 4.5 percent, compared with 5.4 percent for 401(k)s. IRA holders often pay fees that can be two to three times higher than the fees paid by employee benefit plan participants.”

Borzi believes that Americans with 401(k)s and IRAs are entitled to receive impartial investment advice and wants to ensure that you can see the fees you are paying. Her new proposals would protect us and our IRAs from conflicts of interest and self-dealing by correcting outdated 1975 rules.

The brokerage investment community is having a fit because many IRAs today are held by brokers, not advisers. Brokers do not have to live up to a fiduciary standard and can get paid for advice by commissions for trades and by getting a piece of the fees you pay to mutual funds. Brokers claim they are not fiduciaries because they “disclaim any understanding that their advice might constitute a primary basis for the IRA holders’ investment decisions.”

If brokers become fiduciaries, they could not accept commissions or revenue sharing payments. To do so would constitute “fiduciary self-dealing,” which is prohibited. They would have to be transparent and show you what you are paying.

They have submitted hundreds of comments, even going so far as to claim that Borzi’s proposals would increase costs to the investor.

Borzi is on a mission to change the system so anyone getting advice on IRAs could receive an extra 1 to 2 percent return by eliminating the conflicts. Fees would go down and investors would retire with more. There are 75 million IRA accounts with $4.7 Trillion invested. If she impacts half of that and help investors keep another 1 percent, that’s almost $24 billion each year that will stay in our pockets.

Ulysses possessed uncommon wisdom. He knew that his journey required that he pass the Sirens, but he wanted to hear the Sirens’ call. He knew that doing so would render him incapable of rational thought, so he put wax in his sailor’s ears so that they could not hear. Then they tied him to the mast so that he could not jump into the sea. He ordered them not to change course under any circumstances, and to keep their swords upon him to attack him if he broke free of his bonds.

Upon hearing the Sirens’ song, Ulysses was driven temporarily insane and struggled to break free so that he might join the Sirens, but fortunately his forethought and thorough planning worked, saving both his life and the lives of his men. Modern psychological research has revealed that Ulysses was onto something when it comes to managing the human psyche, which translates well to managing a retirement account as well.

In recent research by Dr Read Montague has uncovered ground-breaking insight on dopamine neurons. He gave subjects $100 each to invest in the stock market, supplying information on market trends and conditions from actual but not yet revealed historic market periods. Each subject participated in 24 rounds of investing, and would get to keep their earnings while Montague monitored the dopamine response in their brains.

What did Montague learn? When an investor placed a bet with 10 percent of his portfolio and saw his investments shoot up in value, the dopamine neuron pattern revealed a fixation—not on the winnings, but rather on the missed profits as his neurons calculated his possible returns relative to his actual returns.

So what would the subject do in the following investment round? He would wager more and more of his portfolio in search of the profits he previously missed in an effort to drown his regret with pleasurable dopamine. Interestingly, the longer the investment provided returns, the more the subject would grow in confidence that he had figured out the winning formula, forming a type of investment bubble that would end in utter surprise when the markets corrected and the bubble burst.

Another modern neuroscientist, David Eagleman, has provided some additional research into the brain and investing. In his recent book, Incognito: The Secret Lives of the Brain, Eagleman reveals that the conscious mind is not at the center of the brain’s action, but rather at the periphery. Our conscious decision making activity is often being directed by a staggering complex and competing neural sub-population.

One population looks at chocolate chip cookies and sees pleasure, another sees a high-energy source for survival, and yet another sees an hour on the treadmill at the gym. An unconscious democratic process unfolds inside our minds resulting in a split-second decision to eat or not eat the cookie. And while the cookie debate is fairly easily understood, the subconscious process becomes much more complex and subversive in areas such as finance. That is why Mr. Eagleman recommends that we make well-devised plans during moments of psychological clarity to help guide our minds in the important areas of life.

When it comes to portfolio management, many everyday investors do not have clear and strong investment principles to guide them. They are left subject to the Sirens of greed, fear, jealousy, and a host of other anxieties fomented by media, society, and Wall Street, which eventually lead to undisciplined and irrational investment decisions.

In contrast, professional portfolio managers work within strict asset allocation models that are rarely changed and only with strict review and committee decisions. Such institutional money managers know how to block out the Sirens and stay the course.

Ulysses was wise enough to foresee the temptations ahead and designed a plan to stay the course. Psychologists now call this mental discipline a Ulysses Pact. Do you have enough psychological clarity to know that down the road you too will want to abandon your investment ship in search of Siren songs of our day? Market swings, stock tips, bubbles, and stories of remarkable profits at cocktail parties will leave those bereft of a portfolio style Ulysses Pact tossed about by temptation, and apt to dive headlong into disaster.

The Sirens song will be strong. By forming a clear and rational portfolio allocation plan, and committing to stay the course over time through rigorous rebalancing, you can avoid the shoals and sail on toward retirement safety.

“It’s my nature,” says the scorpion. “That’s what I do.”

When you choose someone to help you with financial advice, it is important to know “what they do.”

In professions where the provider is helping individuals with highly personal and important areas like health, credentials mean that the person has earned the right to be trusted. There are understood standards and norms. Doctors are credentialed for his field of medicine. Chiropractors have a different type of training and certification than an oncologist. We know who we are seeing and what they are supposed to be able to do. Attorneys who have passed the bar went through law school and have the legal right to practice.

Such clear certification is very confusing in financial services. It may look like a professional broker at Merrill Lynch or Morgan Stanley provides the same service as someone who is a registered investment advisor. But nothing could be further from the truth. This distinction is critical to understand no matter how much you trust the individual.

A person who is a broker, is just that. He acts as an agent between a buyer and seller of products, usually for a commission. Legally, an individual who works for a “broker/dealer” must pass a “Series 7″ exam, which teaches one about the stock market and securities to prepare the individual to sell commissioned products. Brokers operate under a “suitability standard” under which the broker is required to make investments he judges to be suitable for his clients. He can’t sell micro-cap volatile stocks to old ladies. Brokers and their firms are regulated by a “self regulated organization” (not a government agency) called FINRA. In the industry, brokers are measured by the amount of commissions and fees that they generate from selling products. Product providers pay more for “distribution” through brokers.

Registered investment advisors (RIAs) help individuals manage their money. They must pass a “Series 65″ exam, which tests how well one knows how to help a client invest and operate under a fiduciary standard. That means an advisor is required to act in his clients’ best interests, and disclose to them all conflicts of interest. These advisors are either registered in the state in which they operate, or with the Securities and Exchange Commission (SEC). RIAs are usually measured by assets under management (AUM) because the more assets they manage, the more their fees. They submit lengthy ADV II forms online showing any conflicts of interest, sanctions from the SEC, and exactly how they are paid.

RIAs can’t use customer testimonials in advertising and must disclose when they pay for client referrals. Brokers can use testimonials and hide fees they are paid for referrals.

Under Dodd-Frank, legislators are now considering implementing a fiduciary standard for brokers. They are fit to be tied. The central issue is that if they are required to put your interests ahead of theirs, they will have to disclose conflicts of interest and fees. FINRA is spending a fortune to fight this because if they disclose all fees they receive from all parties, investors will get wise and they will earn less. FINRA’s CEO earned nearly $3 million last year, and FINRA’s top 10 employees all earn over $1 million. They don’t want their members paying them less, so everyone is pulling out all the stops.

A good analogy for the broker versus investment advisor is the difference between an optician and an ophthalmologist. An optometrist conducts eye exams and makes sure that you have healthy eyes but makes money primarily selling you glasses and contact lenses. When you have a cataract, or something serious, you go to a medical doctor—or an ophthalmologist. He has taken a Hippocratic oath to practice medicine ethically. He sells nothing. He puts your health first and can also examine your eyes.

Do you want to trust your money to someone who is just paid for advice? Or a broker who makes money providing advice in order to sell products?

Just remember: If you’re carrying someone across the river, you may want to check on “what they do.”

The numbers are in – employment growth down, real estate down, manufacturing down, debt problems at home, debt problems abroad and so the financial pundits have come forth from their glass towered temples to offer their counsel. And like well-behaved cattle, the mooing masses have left their fair pasture and are being herded through the rancher’s gate to some unknown but new destination that will provide the hoped for upgraded cud for the chewing. Or might it be the slaughterhouse?

Herd mentality is well researched and highly documented amongst philosophers such as Søren Kierkegaard and Friedrich Nietzsche , scientist Wilfred Trotter, psychologists Freud and Jung, and economists such as Thorstien Veblen to name only a few. It is easily seen in investing through the cyclical frenzied buying (bubbles) or frantic selling (crashes) of the stock market. These sudden swings are rooted in irrational investing practices and driven by emotion – greed in bubbles and fear in crashes.

New economic data is acted upon within seconds by leading professional portfolio managers armed with cutting edge rapid response technology. These “in-the-know” active managers move the market. The media then reports. Articles grace the front page of national publications and prime-time television. Jim Cramer starts banging and bonking his toys while he yells out “sell, sell, sell,” and the frenzy is afoot.

Our current market is characterized by plenty of mooing these days. Six straight weeks of market losses have not been seen since 2002, and have pushed the Dow Jones industrial average below 12,000 after an exuberant eight-month run in which corporate profits and share prices soared. Just when retirement accounts of ordinary Americans began to look healthy again, bang! We are thrust back into dark times.

And boy, does this type of news preach! This is when the herd really gets moving. Investment advisers are inundated with bleating customers asking to be moved into defensive positions. With herd-like agility, these investors have a knack for timing the lows with perfect precision. Never mind the fact that the system is rigged to slaughter the slow moving cattle that seem to always make their move a bit too late. Still, year-after-year, these retail investors are easily rounded up for the slaughter by the pros that know how to really make a real profit.

Investors forget the fact the stocks do not rise steadily over time. They do so in a rather abrupt series of fits and starts with a few days of large gains sprinkled randomly throughout the year. According to finance professor H. Nejat Seyan, if you missed the ninety best-performing trading days from 1963 to 2004 your annual returns plummet from 11% to 3%. Indeed, you would need to be an oracle to accurately pick the 90 best days out of 14,694!

Suffering from collective irrationality, these investors are like sheep without a shepherd, lacking any sense of long-range vision and guiding principles to anchor their portfolio management.  They are unsheltered, exposed and ready to become prey. They are ships without moorings. Their portfolios are tossed to and from in the market’s choppy seas.

The First lesson of Wall Street is to exploit mass-market psychology by acting in a contrarian fashion. Studies by economists and psychologists have found that investors are most influenced by recent events — market news, political events, earnings, and so on — and ignore long-term investment and economic fundamentals.

As a retirement investor, you have a few clear and simple choices. You can enter the active management fray and compete with the big dogs, you can follow the masses and fall prey to the bloodletting, or you can rise above it all by rooting your investment philosophy in proven science and long-range planning. Driving fees mercilessly down, embracing basic global asset allocation and contrarian rebalancing will deliver you from cud chewing and into a Kwai Chang Caine, Zen-like peace. Instead you can rule your portfolio with long range and academically proven principles, and invest effectively and with peace-of-mind.

Greed glands were on fire last week when LinkedIn went public. Maybe this was your
mental ticker tape: “ How could I have gotten in on that action? Why did I miss Linkedin
and now Yandex? When Zynga, Facebook and Foursquare IPO how can I get shares?
How about all those Silicon Valley geeks getting rich again and I’ m not! Are new social
networking companies going to become another tech bubble and will I profit from it?
Am I going to just sit on my hands? Maybe I’ ll just buy LinkedIn now at $90. It is a
good company. I use it. It will eventually go higher.”

That’ s the greed gland talking. There’ s no doubt that LinkedIn is a fantastic business!
This professional network has over 90 million members will soon have revenues of $400
million and has a model with all of the wonderful characteristics of a web-based business.
But it is likely not worth anywhere near $9 billion today. Fortunes have been lost buying
great businesses at the wrong price. Fortunes have been made buying bad businesses at
great discounts (Warren Buffett called it “cigar-butt” investing).

The greed grand and its secretion of envy will drive you to buy when you feel you are
being left behind. Those who fall prey to it become speculators. It might be wise to clip
the following words and read them when your greed gland starts convulsing:

When you invest or loan your money to companies that operate in our capitalistic system,
you as an owner will be paid. Over the time period that retirement investors care about,
say 20 or so years, that return has been in the 8% – 10% range. Think of capitalism as a
train. If you get on it, your money will grow just because the system demands a return
on invested capital. Over the journey, the train will slow down, backtrack, or speed
up, but it will keep chugging along. Eighteen years ago in 1993 you could have bought
the S& P 500 in a newly minted product called SPY (the first Exchange Traded Fund)
for $33. Today SPY is worth four times that – $132. You’ d have made no decisions,
clipped some dividends and paid minimal taxes without breaking a sweat. No CNBC, no
commentary, little anxiety. Just by owning your small piece of American capitalism.

If you get off the train, you become a speculator, thinking you can get farther than the
rest of us who are on the train. Speculating is thrilling and it cures the temporary itch of
the greed gland. But there are two problems that few overcome. First, you pay taxes on
the gains so your winnings are automatically cut by one third to one half. You have to
run even harder and faster. And second, all speculators make mistakes. Few investors
like to talk about investment mistakes, but everyone makes them. Every seasoned
professional investor knows that avoiding and limiting the inevitable mistake is the single

most important characteristic of investment success.

If you think you have a talent for buying LinkedIn and other IPO shares and sprint ahead
of the train, you may get a town or two ahead this year. But sooner or later, you will
make a mistake. You’ ll buy too high on an oversized bet and feel pain as your losses pile
up. Like all speculators, the train will pass you or run over you at some point in the next
10 or 20 years. Your friends will be having fun on the train and you’ ll be roadkill. So
please, just stay on the train, buy yourself a drink and enjoy the ride.

Lining his own pockets with over $63.8 million in illegal windfall from his insider scam, this once humble Sri Lankan son of a sewing machine company manager grew in physical, egotistical and financial stature. Through his swollen cheeks he crowed to friends about his $7 billion hedge fund empire, stating that Raj, which stands for “King” in Sri Lankan, makes him the “King of Kings”. How about the Insider King instead?

Indeed, Raj Rajaratnam, did gorge himself like a king, but on more than just Kobe beef. Using techniques once reserved form organized crime, drug trafficking and terror plots, the Justice Department was able to convict the Insider King of 19 accounts of security related fraud. And his conviction involved a complex web of over 23 known complicit parties ranging from corporate executives to hedge fund managers revealing just how deep this insider culture truly runs among the Wall Street elite.

With the spotlight temporarily on this aspect of the malevolent hedge fund underworld, it behooves us to pause and underscore a few key lessons for the everyday investors.

Lesson #1 – The Little Guy Can’t Win

Every now and again you run into that day trader or active investor who has discovered the “golden cross” of technical analysis or has gained some yet-to-be perceived insight into the global economy which he is poised to exploit.

Forget the fact that thousands of financial researchers churned out of the top ivy league schools are employed by leading hedge funds, equipped with staggering research budgets, sophisticated analysis technologies and shocking financial rewards for success. Forget that these researchers are probably a bit smarter than you. Forget that they crunch data like auto bots, day after day looking for any edge. Forget that even if the playing field were level, you would have to be a bit deluded to want to compete against such a formidable opponent. Then add to these facts the simple Insider King illustrated reality that these organizations sometimes get trading information first – illegally, and the answer becomes simple. The little guy cannot win.

For the individual investor, active stock trading is nothing short of Popeye fighting Bluto with no spinach in site. Such a contest is so one-sided that it goes from being entertaining, past pathetic to downright disgusting. As the Las Vegas adage goes, “look around the poker table and if can’t spot the sucker, it’s you.”

Lesson #2 – Fees Really Do Matter

What does 2 and 20 mean to you? Probably not much unless you have read the prospectus for a hedge fund. The going rate for playing in the hedge fund game is a 2% annual management fee on assets under management and then a 20% profit share on all earning. This is the fee burden the hedge fund manager must overcome to return value to the investor group.

With such a heavy fee burden, how then does long-short equity hedge fund manager return value? He does so through building teams that perform deep research, astute analysis, and rapid response systems which exploit the smallest window of opportunity. And sometimes he do so, as the Insider King has shown us, through insider information. Surprisingly, even with all these resources and advantages, many hedge funds over time fail to even beat the market. 2 and 20 is a lot to overcome.

Lesson #3 – Some Things Never Change

Yes, the Galleon verdict is an encouraging example of justice, but just how deep is the insider problem? According to the Cayman Islands Monetary Authority, there are over 5000 hedge funds representing over $2.3 trillion in investments. And although many of these funds conduct ethical enterprises, the dollars at play provide a substantial motive for misbehavior. Galleon is just the tip of the iceberg.

When malfeasance turns up, however, investors are frustrated by the fact that many cases are lost in court or end with nothing more than a wrist-slap. The not-guilty verdicts for Bear Stearns hedge-fund managers accused of misleading clients, Angelo Mozilo’s multi-million settlement to erase fraud charges with the Securities and Exchange Commission, and the lack of indictments against Wall Street executives for misdeeds in the financial crisis are all examples of injustice winning the day. One commentator likened these efforts to a fruitless and frenetic game of whack-a-mole. You may strike a mole here and there, but a lot more disappear into their hole to never face any consequence for their action.

Although we applaud the conviction of the Insider King, remember that when it comes to Wall Street, some things never change.

The individual investor, however, need not despair. Through simple indexing and global diversification, you can tap into the value of corporate productivity and global economic growth and thereby side step the rigged world of active trading. Add to this the discipline of vigilantly driving down all unnecessary fees within your portfolio, and in the end, you may in fact have the last laugh, even on the Insider King.