How Wall Street Works On Your Fears

Posted on October 11, 2012 at 12:31 PM PDT by

One of the most effective marketing tactics on earth is the power of mystery. How Wall Street works is by playing on our deepest fears of inadequacy. Wrapped up in the confusing math of finance, investing seems far out of our reach, something best left to professionals and their arcane knowledge.

Yes, some things are better left to professionals. If a specialist tells you that you have an unusual heart condition and should consider a specific course of treatment, well, you should. (Of course, a second opinion is a good idea.)

But you don’t need a heart surgeon to warn you against eating fatty foods and sitting on a couch all weekend. The long-term effects of poor diet and inactivity are obvious to us all. How Wall Street really works is just about as simple as getting up off the couch. Hard to do, but easy to understand.

how Wall Street works

In terms of money and investing, there have been a lot of changes — good changes — that have allowed ordinary people to take charge of their own financial futures, to get up off the couch and make choices in their lives. Think about it: Twenty years ago, nobody other than a professional would consider personally buying a common stock. That’s what brokers did for you. Today, people click a mouse and snap up thousands of shares without a blink.

Choosing an investing strategy, too, was the job of the green-eyeshade-and-suspenders types. You paid for that kind of advice. Often, it was just a stock answer cribbed from a finance journal, commodity information that an advisor would mark up dramatically. But it seemed tailored to the individual. That’s how Wall Street works. Who would know the difference?

The “mystery” of finance thus gives experts the power to profit from our personal insecurities. It’s a simple fear premium. But a high price also sometimes perversely signals high value. Consider how perfume and even coffee is marketed. Who wants to buy a cheap cologne, right?

That’s how Wall Street works even today. Fear means pricing power. From Forbes:

A new study released by Hearts and Wallets confirms the fear among individual investors. There is little appetite for risk-taking in general, and 41% of the 5,400 households surveyed say that they are “inexperienced” when it comes to investing. This number is up more than 50% in just one year. The results were consistent across all ages and lifestyles. Only 25% of respondents said that they were comfortable accepting investment risk in order to achieve higher returns.

Okay, so here’s a quick course in Investing 101. First things first: How Wall Street works is by charging you commissions for simple, repetitive actions that do not take a considerable amount of intelligence or time. The other way Wall Street works is by charging you fees for advice that, one presumes, is worthwhile.

Notice that I said “how Wall Street works,” not “how you retire on time” or “how you keep more money.” The difference is crucial.

Your first goal as an investor is to keep it cheap. On commissions, if you buy one share of a stock, or a thousand, you pay the same. You pay when you buy and you pay when you sell. So, one way to fight those costs is to trade less often, find a way to trade for free, or both.

As for fees, the fundamental bargain is that you should be convinced — by evidence, not marketing and not blind faith — that a manager or an advisor is able to “earn back” those fees with performance, consistently, for years. Unfortunately, evidence that this is possible is vanishingly small. A manager might “win” one year and the next, even have a bit of a streak. Then he or she inevitably gives it back, and more.

How Wall Street works for real

Absent these two important features — low fees and minimized trading — it is nearly impossible for a retail investor to build wealth using the markets. He or she would be better off learning a new job skill or investing in a small business.

Investing is boring. But that’s how Wall Street works. They take your money and do, mostly, simple things with it. Then they charge you too much for the result, erasing any advantage you might have gained. Fear is the moat that protects their business.

As for investing strategy, decades of finance research has reached a simple conclusion: A balanced portfolio of varying asset classes in low-cost funds, periodically rebalanced to stay in line with your goals, drives your ultimate return. I wish I could say it’s more complicated than that, but it’s not.