Wall Street’s Biggest Lies

There was a great interview this week between Quartz’s Matt Phillips and The Wall Street Journal’s Jason Zweig. Phillips asked Zweig about risk in the stock market and the need for higher returns by many investors. His response about one of the biggest lies on Wall Street was really important for investors — and savers — to understand:

The only thing that’s within your control, really, is your saving rate. So you have to save more money. If you don’t save more money you cannot count on the stock market to bail you out.

And I think the big lie on Wall Street and in the financial-advisor community is a sentence that begins kind-of like this: “You’re going to need to earn higher returns so we’re going to buy you some of these…” Well, it doesn’t matter what you need. You could need a 20% return, you could need a 15% return, you could need a 10% return, but the stock market doesn’t know and doesn’t care what return you need.

You’re going to get the return that the stock market “needs” to provide you…which is why saving more is really the single most effective thing that people can do.

I like Zweig’s take here because he not only offers up a falsehood, but then follows it up with a solution. It’s easy to point out what’s wrong with the world of finance, but very few people are willing to offer up suggestions for how to actually help people.

This take on one of Wall Street’s biggest lies got me thinking about some of the other fibs and embellishments that tend to come from the finance industry. Here are a few of my additions to Wall Street’s biggest lies:

1. That they know exactly what’s going to happen. Certainty and overconfidence have to be two of the biggest reasons for losses in the markets. Intelligent investors understand that you always have to work within a framework of probabilities, but hearing someone tell you that they know exactly what’s going to happen with complete certainty can be very seductive to investors who are worried about their life savings. I’m always weary of those who make too many promises or use the words ‘always’ and ‘never’ on a regular basis.

2. That newer products are always necessary. There were 361 mutual funds in 1970. By the end of 2014 there were almost 8,000. That’s in addition to nearly 7,000 ETFs. To put that into perspective, there are only roughly 3,700 stocks in the entire U.S. stock market. These funds are spread over almost 900 financial firms from around the globe who compete for U.S. market share. Since 2004, an average of 650 mutual funds have been created each year while an average of 533 have been closed or merged with other funds.

Obviously, there are products that have been launched in the time that have been helpful, including ETFs. But Wall Street will continue to pump out more and more products each year with the hope that a few will work and customers will oblige by chasing hot investments. Investors should be skeptical of the majority of new investment products that hit the markets unless they truly understand them and have a legitimate reason for investing in them.

3. That risk is easy to measure, define or hedge. You would think that after Long-Term Capital Management’s PhD-driven risk models blew-up people would have learned their lesson about the difference between market risk and model risk. Obviously, the financial crisis taught us that many financial firms were still overly reliant on unsound models and spreadsheets to tell them what was safe and what wasn’t. It’s difficult to use common sense as an input in a value-at-risk calculation, so these problems were more about user error than anything. Far too many financial firms assume that their risk models are infallible and present the brain-power behind them as proof.

There’s never going to be a perfect way to measure or model all of the risks in the markets because humans are unpredictable. Plus, risk is mostly a personal thing that can vary from investor to investor.

A few other quick-hitters:

“Just trust me. You need to invest in this.”

“Yes, you get what you pay for in terms of fees.”

“It’s just like a bond…it’s a bond substitute.”

“All of the upside, yet none of the downside.”

Jason Zweig on Wall Street’s Big Lie (QZ)
ICI Factbook

Further Reading:
Lies Investors Tell Themselves

Now here’s the stuff I’ve been reading this week:

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What's been said:

Discussions found on the web
  1. ryan harvey commented on Dec 10

    I think that by far the biggest lie told by Wall Street is that its suitability-standard “advisors” are actually providing advice.

    • Ben commented on Dec 10

      Good one. Very true.

  2. Matt Downing commented on Dec 11

    This is great. I especially like your “They know what is going to happen” and “trust me.” So often it is easy to give into people who seem smart or powerful or wealthy. And it is especially difficult to see through them when that person possesses all three. Thanks for this. 13monthsecuador.blogspot.com

    • Ben commented on Dec 11

      yes and people want to believe that these people know what they’re talking about

  3. Steve commented on Dec 11

    All the upside and none of the downside. That’s how many salesmen sell annuities…..
    It’s all about commissions…

    • Ben commented on Dec 11

      very true. makes for a good narrative

  4. Market Map commented on Dec 11

    Wall street represents product sales / fees, impulsive trading, and lack of “skin in the game” quantitative research. There’s big $ in steering boomer investors and savers into “products”. As Wall Street is structured on product sales and fees, “alpha production” is lost because investing methods arise from esoteric complex processes that are based on
    experience with the markets and quantitative skills. Experience is
    personal and difficult to convey to others. Quantitative knowledge can
    be achieved only through advanced education, an elaborate process and an irrational expert will disclose an edge.
    Even something as simple an empirically tested low transaction frequency, moving average cross strategy applied to a broad equity index and long bonds has produced alpha premia vs. buy and hold over many CAPE overvaluation periods historically, yet it is lost amongst the noise and non existent within product lines. So the small investor is stuck in a quagmire …

  5. Mark Massey commented on Dec 11

    I tell my clients there are 3 things they can definitely control: savings rate, asset allocation and investment expenses.

  6. sternalot commented on Dec 11

    “In the long-run, the market only goes up.”