Sunday, April 24, 2005

Join us at the poker table

There's an obvious reason for Wall Street to support Social Security privatization: if everybody puts money into mutual funds, investment firms stand to pick up more money in management fees.

There's a smaller reason, which has attracted some notice: if more Americans have money in the stock market, they might be motivated to support pro-Wall-Street policies.

And then there's a subtle and devious reason which hasn't attracted much notice at all: the crafty folk of Wall Street want more patsies at the poker table. They want a huge crowd of bad investors who'll buy aggressive-growth mutual funds at the top and sell them at the bottom. That's because they want some beginners to whom they can sell high and from whom they can buy low. Most Americans, like dear old Bob, fit this description. Scams like the one that caught Bob aren't even the issue here. But if he was tricked so crudely, you can guess that his intuitions about market timing aren't likely to be reliable, and may even be a contrary indicator.

As the research director of a dorm-room hedge fund back in my college days, as someone who made and lost a fortune in the Nasdaq bubble, and as someone who's been doing reasonably well in the market over the last couple years, let me point out that there's an emotional side of investing that takes time and pain to learn. It's natural for beginners to buy stocks without seriously imagining how it'll be if, despite their best-laid plans, the stock drops 50% and stays there for a few months. Sure, you say you believe in the company and you'll hold on, but you don't know the emotions that'll be working on you unless it's happened a few times before. Vividly imagining all possible futures is key here. Having a reliable and tested method of investing that you trust, come hell or high water, is also very important.

People who can fully visualize the future possibilities, and who've developed time-testing methods for investing, are going to be taking money from those who haven't. Put simply, the hedge fund managers are going to take the money of hard-working poor folks and feel good about doing it. As the old line goes, when a guy with money meets a guy with experience, the guy with experience gets the money and the guy with money gets the experience. So there's reason to be suspicious when the privateers point to the high historical returns of stocks. On average, people break even playing poker, but that doesn't mean I'll be safe taking my fellowship check to an online poker website.

1 comment:

Bill said...

It is no suprise that some of us on The Street support the privitization of social security. The first reason you stated (higher management fees/comissions) is probably the biggest reason, and your focus on bringing more fish to the poker table is something people here are definately interested in. I have never heard the reason that it might make people more sympathetic to Wall Street policies, but that sounds reasonable.

However, there are some in finance ( e.g. Warren Buffet, the second richest man in the world ) who think that the privatization plan is a bad idea, even from purely selfish interests. Firstly, this large influx of new money int the market, especially without thoughtful investing is likely to dilute the risk premia where many people make their money. This will lead to lower returns for everyone, financial types and workers alike.

Secondly, the current SS trust fund invests only in US treasury products. If it stops doing this, the US will still have to finance that debt somehow. I can go on for a while about why a large national debt is bad for Wall Street, as well as for everyone, but I do not think I need to in this forum. But let me point out that Wall Street is not just the stock market, we have bond traders too.

Finally, any hit to the economy, in any sector, as this SS plan seems like it would do, can affect the Street. We actually have a stake in sound fiscal policy by the gov't.

Enough of my ranting, back to work.