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Where are the Customers' Yachts?
By Stephen J. Butler |
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This month's
congressional hand-wringing over the extent to which the public
should be protected from brokerage firm analysts reminds me of
two books those in Washington should be forced to read. The first
is "Where
are the Customers Yachts? A Hard Look at Wall Street"
by Fred Schwed. The second is "Do
You Want to Make Money or Would You Rather Fool Around"
by John Spooner.
"Where Are the Customers' Yachts?" was written in 1940, republished in 1955 and again in 1995. That says a lot about the book's timeless quality and the extent to which a business built upon human nature is so resistant to change. The title is based on that legendary question that came up when J.P. Morgan was ushering a customer around the docks of the New York Yacht Club. The fact that all the boats were owned by investment firm partners rather than their customers said a great deal about Wall Street that remains true even today.
"Do You Want to Make Money or Would You Rather Fool Around" is a new book full of insight by the author of "Sex and Money" and "Confessions of a Stockbroker." Spooner has been in the investment business for forty years, and we can learn a lot from someone successful and confident enough to serve up a juicy, jaundiced view of the industry.
Setting aside their sheer entertainment value, the purpose of reading these books is to develop a more accurate expectation of what the financial services industry can accomplish for us. These books reinforce what we should already know---that there is no substitute for doing our own research, making our own decisions, and getting professional help when we feel we need it.
For example, in the investment business, history does repeat itself, but it does so only slowly over long periods of time with lots of surprising variations along the way. This is why a long time frame for investing in stocks is so important. With only a few exceptions, anyone who claims to be able to predict the future performance of an investment has no better chance than any of us of being correct. If they can demonstrate having been right in the past, a major part of their success was due to basic luck and its laws of probability.
"Speculation is an effort to turn a little money into a lot. Investment is an effort to prevent a lot of money from becoming a little." Fred Schwed points out that the odds of turning a few thousand dollars into $25,000 in a year are about one in twenty five. The odds of investing $25,000 and receiving a few thousand in annual gains are the exact
opposite. The past few years have offered a real time example of these odds. There were stocks in the late 90's that increased by a ten times factor within a year. Then, in 2000-2001, the market lost 20%. Based upon historic stock market standard deviation statistics, this downturn has about a one in twenty-five chance of occurring. The last time we had a severe and prolonged downturn was in the mid-seventies almost exactly twenty-five years ago.
"Was it stolen or did you lose it?" is the question asked in "Where are the Customers' Yachts?" Much of the criticism of Wall Street focuses on actual lawbreakers, but while millions may be stolen there are billions being lost. Take the Enron employee whose recent $700,000 in their 401(k) is now worth $1,400. Violating a basic investment axiom with no diversification is an example of what happens when "bad luck and bad brains meet together in an effort to do something that couldn't have been done in the first place." We all know people who have gotten in and out of an investment at the right times, and maybe we have been so fortunate ourselves from time to time. However, in the aggregate, it doesn't happen. A collection of the finest investment minds running money for large pension plans fails to meet either stock or bond averages.
In "Do You Want to Make Money or Would You Rather Fool Around," Spooner points out that most people never make money in the stock market if they are buying individual stocks for their own accounts because they can see prices every day. It influences them emotionally. In my own experience, while standing at the turnstile of annual pension accounting, I have seen this demonstrated over the years. At one point, in the mid-eighties, I remember reading that 80% of all small investors using major national brokerage firms were losing money over any five-year period of time. In fact, during the greatest sustained increases in the history of the American stock market, I sat and watched those losses happen in many retirement accounts.
Spooner's book has a lot of good information on when to sell a stock or when to buy more. There is a compelling argument for buying individual stocks instead of mutual funds with money outside a retirement account, because you can control the tax impact on your portfolio. He points out that we should consider purchasing even more shares of any stock that has tanked but that we still believe in. This reduces our average cost, so we can be rewarded sooner during an eventual turnaround. Also, selling a troubled stock that we otherwise want to hold, and buying it back thirty-one days later, is a way to create a loss that we can then use to offset some gains. The control of tax and management costs with individual stocks will go a long way toward setting the stage for beating the net after-tax returns of the average fund.
Finally, when it comes to seeking professional help, Spooner suggests that you seek someone who knows about human nature. Investing, after all, is all about the conflict between fear and greed. People who think it's about mathematical analysis are barking up the wrong tree. Ask the advisor to explain their investment philosophy and ask them what investments they own themselves. What have they learned from their successes and failures?
At the same time, we need to ask ourselves the same question, because we do, after all, have an inclination to make the same mistakes over and over again. Effective investing starts with introspection, and introspection is not without some pain. To truly great investors, however, "pain is just weakness leaving the body."
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