Recently I suggested that someday it might be illegal for untrained citizens to invest in stocks of individual companies because it is too risky. As regular readers know, I sometimes throw out provocative ideas just for the fun of it. I didn't think much about that idea until after I wrote it. But the more I mulled it over, the more it started to make sense. So I'm going to develop that argument here.

I remind you that I lean libertarian (without the crazy stuff) so all of my impulses are to allow people the freedom to hurt themselves any way they choose, so long as their corpses don't block my driveway or cost me anything. So the argument I am about to make offends even my own sensibility. The troubling part is that it makes sense.

Let's begin by noting there are already plenty of restrictions on personal freedoms when the consensus is that these restrictions somehow protect people from themselves, or they protect society as a whole. For example, where I live you can't legally...
  • - Drive without a seatbelt
  • - Ride a motorcycle without a helmet
  • - Commit suicide
  • - Practice law, medicine, or other professions without a license
  • - Operate a motor vehicle while under the influence
  • - Gamble in most places
  • - Carry an Uzi down the street
  • - Buy dynamite

The list goes on, and that doesn't even include the many restrictions on underage activities. So there is nothing unusual or unprecedented about legal restrictions on freedom when an argument can be made that it protects lives or property.

My argument against allowing individuals to invest in stocks is that unless you have insider knowledge, which is already illegal, your odds of beating the index averages are slim. It is nothing more than gambling.

The myth of stock investing is that a person who does more research has better results. But there is no science to support that view. Indeed, the person who understands the most about individual stock investing avoids them completely and invests in ETFs or index funds.

The problem with doing your own research on stocks is that you must rely on the information coming from the management of a company, and managers are generally misinformed or lying. Even the most seasoned investment professionals running mutual funds perform worse than the indexes on average. Brains and research can't overcome the fact that much of your data is deliberately tainted at the source.

When people go to Vegas to gamble, they usually set some sort of limit for their losses. And they go with the full knowledge that winning is unlikely. It makes sense for that sort of activity to be legal, within limits, because it is viewed as entertainment and not investment. But if it were common for people to bet their retirement savings on Blackjack, you can be sure it would be illegal.

We don't allow unlicensed people to practice law or medicine, sell real estate, or even build a house. It is entirely consistent to restrict the untrained from making risky stock investments.

I reiterate that this runs against my own libertarian philosophy. I would feel I had lost something important if I couldn't invest in individual stocks. But it is also true that my net worth would be larger if I had never done it. And it would be larger still if I hadn't allowed professionals to do it on my behalf.

If anyone comments to this post by saying, "I do my own research and I made money in the stock market," it is proving my point. And if you don't see why that proves my point that further proves my point.

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Jan 10, 2009
Its good that this blog is not too popular. How about banning investing in Real Estate.
Based on this point in history, there is no proof which investment is the best. Most of the
disasters in stock did not result from owning individual stocks, but from people not
diversifying or trying to buy high-flying names, just like Mr. Adams did.

People who owned 10-20 large stocks over a long period of time and reinvested dividends
have actually fared just as well if not better as indexers. Large caps make a big part of the
Index to begin with, so their crash is the index crash, and they pay dividends which small
companies do not. Dividends make up 30% of the stock appreciation. But they dont tell
you that, because by pushing you into indexing, they make you buy also very risky companies
you would not dare own otherwise. Indexing is owning stocks.

Mr. Dilbert is also suggestive that there is a moral obligation there to help people create
wealth or that the government should advise people on investing. Or that we owe it to
people thay hey become good investors. We are owed nothing. We can do with our money
as we like, and chose who we trust an who we dont.

And by the way, Bernie Madoff investors did not own individual stocks.
-1 Rank Up Rank Down
Jan 2, 2009
I think you are focusing on the Baptists instead of the bootleggers in your other examples. Theoretically, yes, many of them prevent people from harming themselves or others, but if we think self harm is okay, harming others is already illegal, so many of the above laws are already redundant. Is it more illegal to hurt someone while you're drunk?

It is difficult to get laws that are purely for the common good passed, so there is often some amount of pork in every law. The biggest example for me is professional licensing. Have you ever read The Undercover Economist by Tim Harford? He explains how restricting the number of doctors or lawyers is not always about the public health, but about raising the price they can charge with their new scarcity.

Also, it seems to me that government regulation already had a large role to play in this most recent financial crisis. Laws that require cars to meet ridiculous requirements make American car companies unable to compete (it's not just Ford, but also companies that have plants in the United States). Laws like the Community Reinvestment Act of 1977 the force mortgage companies to loan a certain number of subprime loans and their implicit insurance that the government will bail them out led to real estate and stock market problems. And now that the government is actually bailing out failing companies, I think this falls into the category of moral hazard, where insuring against bad results leads to more of the behavior that we are trying to avoid.

There might also be a bit of moral hazard in welfare and Social Security that encourages more risky investment. I mean, if you lose everything, there is at least a bit of a safety net.

And what are the alternatives? I personally would feel very uncomfortable trusting my savings to a "professional" especially if that professional is a government employee, because as far as I've seen, they do no consistently do better on the stock market than anyone else.

This was a really interesting post, I enjoyed thinking about it, even if I found the idea almost physically painful. ^.~
Dec 30, 2008
">They found that companies with a higher book value to market value ratio consistently outperformed ones with low ratios"

The 3 factor model revealed that certain stocks were undervalued, but because of the efficiency of our system those same stocks quickly become efficiently priced. You won't obtain higher than average expected returns using the Fama-French model any longer.

This reveals two lessons:

1. There are ways to obtain higher than average returns in the market.

2. When you discover such a method, don't tell anyone.
-1 Rank Up Rank Down
Dec 30, 2008
I think you need to quit making claims that you're a libertarian.

>"We don't allow unlicensed people to practice law or medicine, sell real estate, or even build a house"

We don't, but we should. Requiring licenses runs against libertarian principles.

It'd also be nice to learn how exactly your "ETF only" would work. The way I understand it, I am FORCED to invest in poor companies-Enron, WorldCom, AIG-because I have to invest in ALL companies. That means that high value companies aren't rewarded. What a horrible idea.

>"But if it were common for people to bet their retirement savings on Blackjack, you can be sure it would be illegal. "

By definition they are spending their retirement savings.
+1 Rank Up Rank Down
Dec 23, 2008
bernie madoff would have done a fine job of handling your money as a 'professional'.
-1 Rank Up Rank Down
Dec 23, 2008
you're supposed to start leaving the market as u near retirement.
Dec 23, 2008
I suck because I havent read all the comments but I just had to point this out since it looked so funny. Other things that are forbidden
-Drive without a seatbelt || Can lead to DEATH
- Ride a motorcycle without a helmet || Can lead to DEATH
- Commit suicide || Leads to DEATH
- Practice law, medicine, or other professions without a license || Can lead to other peoples DEATH. Death sentence, death from illness or injury.
- Operate a motor vehicle while under the influence || Can lead to DEATH
- Carry an Uzi down the street || Will most likely lead to DEATHS
- Buy dynamite || Can lead to death
- Gamble in most places || You wont die you will lose money.
Buy individual stocks, Will NOT lead to DEATH you will only lose money.
So, why are gambling and investing on the same list as all these lethal activities?

I will now try to shut up.
Dec 22, 2008
Just for the record, I think Phantom II makes a lot of sense
Dec 22, 2008

Many of us have the idea of using cell phones to promote ridesharing, but it requires a big behavior change for everyone. You could lead a national movement to encourage ridesharing. How about it?
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Dec 22, 2008
Phantom II - You, and I am sure you've heard this before, are a self-righteous windbag! The fundamental point that you missed is not one of having the government make decisions for me, it is when YOU make decisions of how they impact ME. Drunk driving isn't about the drunk driver, it is about what that drunk driver can do to others on the road.

Restricting investors is an idea that has tremendous merit and is already in place for private offerings (as noted earlier). This idea needs to pressed forward to the point that our capital markets are no longer crap shoots, but actual, real opportunities for investment return.

If I missed your point in the blah. blah, blah presented - consider an editor the next time you decide to post and spare the rest of us the extra effort of scrolling past your insidious comments.
Dec 22, 2008
Scott, I understand the point you're trying to make, but I think you're missing the bigger point. There is a world of difference between laws that are meant to protect society (drunk driving, for example) and laws that are meant to protect people from themselves. The former are what laws should be about: the betterment of society. The latter are, quite simply, restrictions on individual liberties. When legislatures impose them, it should be with the utmost care that the law is so overridingly important that restriction of liberty is warranted. To me, those areas are few and far between.

To understand my point, first look at the difference between freedom and liberty. Freedom is being allowed to do what you want to do without government interference; liberty is not being forced to do something you don't want to do by the government. Those are, obviously, two different things. In today's US society, the distinction is rarely drawn, and that's why we're losing much of our liberty in the name of freedom. Think about that for a moment.

Dictatorial forces in our government are constantly trying to justify removing our liberties. They say that an individual who harms himself is really harming society. Here's how they try to convince us of that.

First, the government takes a huge portion of productive people's earnings. Then, they use it to fund governmental programs such as health care. Then, they pass laws that say you have to wear a seat belt, because if you don't and get injured, government is going to have to pay for your hospital stay.

This is the insidious way that our liberty is eroded. It starts with taking more of our money; government then spends the money in areas where laws can be written to restrict liberties based on the above logic. More and more people become dependent on government; fewer and fewer pay taxes, so a larger portion needs to be taken out of the pockets of those that do pay them. When government doesn't have enough money, they simply print more or borrow it. And each time they do, a little more of our liberty goes with it.

People need to take responsibility for themselves. It's not the government's business to direct their lives. It's the same thing with buying stocks. If I throw all my money into Amalgamated Flypaper, and it goes bust, then I only have myself to blame. If government forces me to pay into an insolvent Ponzi scheme called Social Security, and it goes bust, whom do I blame then?

Your logic on buying stocks could go into almost anything. We're too dumb to pick a doctor, so the government has to pick for us. We're too dumb to know how much water should go into our toilets, so the government has to mandate it. We're stupid and selfish in wanting to stay cool in the summer, so government is going to install thermostats in our houses that can be turned off remotely (you think I'm kidding? That almost became law here in California). So government, rather than building the infrastructure and generating plants to meet our energy needs, instead shuts down our air conditioning in the name of environmentalism.

People don't need to be protected from themselves. They need to learn how to take responsibility and live with the result. They need to scream at government in their loudest voices from the hilltops, "Get your cotton picking hands out of my life!!!"

If we don't wake up and reject this constant and increasing erosion of our liberties, then soon we aren't going to have any left. Then it won't matter what we want - it will only matter what our rulers decide to do to us.

So Scott, if you don't want to buy individual stocks, then don't. But don't try to take away my ability to do so because you think everyone other than you is too stupid to handle it, and too immature to take responsibility for their actions.
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Dec 22, 2008
mrmighty - back in the good 'ol days, people had to actually qualify for a loan to buy real estate. I realize that this is a strange concept to most today when we are told that we should ALL own a house, and loans were free for the taking, but going through a qualification process might have actually kept the "mortgage meltdown" to a minimum.

I still believe a means qualification test to own individual stock makes tremendous sense.

jeff w - prove it. Can't do it. It is true that most mutual fund managers do not exceed the index they are matching. Plus 1 for Scott...

krazy karlos - that is just, well, CRAZY. Fractional liability is a personal injury attorney's dream, but is ridiculous when applied to corporate ownership. That is why a board is hired and compensated, to make decisions for the shareholder. Looks like you need to take a test, of some type!
Dec 22, 2008
Using the same logic, lots of people lost money in real estate. People shouldn't be allowed to buy real estate without a licence.

There are lots of reasons why it makes sense to own part of a company, and I don't think you accomplish anything good for the economy by restricting ownership to some elite group. The problem with the stock market isn't that it allows people to buy and sell shares, but that people use it to speculate. The same thing happens in real estate, foreign exchange, etc.. People find ways to lose money with government bonds.
Dec 22, 2008
"Even the most seasoned investment professionals running mutual funds perform worse than the indexes on average."

Not a true statement.
Dec 22, 2008
There's another possible approach, one that I've been thinking about for a long time.

If you buy stock in a company; you own a stake in that company. If you buy all the stock, you own the whole company.

If the stock goes up, your investment is more valuable. When the company pays dividends you get a share of the profits the company makes.

If the stock goes down, your investment is now worth less, and there will be lower or zero dividends.

What happens, though, if the company of which you are a "part owner" is responsible for a colossal pollution incident, and billions are required for a cleanup? Or if the pharmaceuticals it manufactures kills or maims a large swathe of people, leading to vast claims for damages? My favourite example -- the cellphone operators were aware, right at the outset, of a vast array of illnesses caused by microwave radiation, and went right ahead, persuading people to put a microwave transmitter against their heads. As the brain tumour rates rise, and the autism rates rise, as the Alzheimer's rates rise, and we wait for the first court case to set a precedent -- people are still investing in telecoms stocks, despite warnings on the companies' SEC filings that they are facing multitudes of claims.

If the company you invest in, and of which you become a "part owner", makes money -- you profit. Surely, if the company you've taken a stake in, does damage, and takes a loss -- YOU, the investor, the part owner, should be liable for the resulting costs?

So before you invest in a company, you have to show that you have the assets, the back-up, the reserves, to take responsibility if that company, makes a big mess.

This is actually the principle on which Lloyd's of London takes on investors in the form of "Names". You can read a very good book called Ultimate Risk by Adam Raphael on the Lloyd's meltdown in the 1980s, when Names (Raphael was one) were sucked into being investors without being warned that if there were underwriting losses, they faced *unlimited liability* with respect to these losses. One syndicate chief, in signing up new Names, was responsible enough to tell the new investor to sign and hand over a blank cheque, which he would put in his shirt pocket, to drive home the point that if the syndicate made a loss, the Name would have to pay up. Many Names lost all the money they had, their homes, their life savings, and not a few committed suicide.

If people were faced with this kind of genuine responsibility, and had to show this kind of financial backing before making a substantial investment (I think this kind of thing should be mandatory for investments of over 1% in a company, say) -- I *guarantee* you that people would do much more pointed research before investing, and would also be forced to keep reserves (which could be a passive part of the deal) which would actually keep their investments much safer in the long term.

A lot of companies -- tobacco, pharmaceuticals, fast foods, big polluters -- would immediately find it harder to gain investors. It would completely transform the way people approached the market, and the way companies put out information on their doings. And investors would be forced to consider themselves truly responsible for where they put their money.

That would sort out a lot of the nonsense quick time, and lead to a much more ethical business world.
0 Rank Up Rank Down
Dec 22, 2008
ETFs & Index funds are NOT, repeat are NOT ways to make high return or "risk adjusted" return in the capital markets. They are, however, excellent ways to keep pace with our economy. Scott, try this on for size: CONCENTRATION is the only way to make higher than market return (also known as Alpha in some circles). Everything else is noise, period. Yeah, yeah, Modern Portfolio Theory says the opposite, but once you look behind the curtain, MPT is bunk. Obviously you shouldn't take my word for it, do a little research - "Black Swan" is an easy place to begin.

Additionally, the type of system you propose is already in place for Private Equity - its called, you must be an accredited investor to participate. It is income and net worth based before the govt thinks you are qualified to take on the risk of private deals. This system can and should be easily applied to individual stock purchases...perhaps a net worth of $250k and an annual income of $100k adjusted for inflation is a place to start?

Dec 22, 2008

On insider information:

"With enough insider information and a million dollars I would have gone broke in a year." - Warren Buffet

There is a story of a Texas oilman who made $1 million from a single well outside of Dallas. The man in question heard the story and turned to his friend:

"Well," he said, "it wasn't really an oil well...it was natural gas.
And it wasn't really outside of Dallas; it was outside of Houston.
And it wasn't really a million dollars; it was two million.
And it wasn't really me; it was my brother.
And he didn't really make it; he lost it."
Dec 22, 2008

writes:A license to invest in stocks? This is one of the most elitist things I've ever heard. And then you finish it off with "And if you don't see why that proves my point that further proves my point." Nice.
And spare us the "I'm a libertarian except when it's not beneficial" line. You're a fair-weather libertarian, which makes you a liberal democrat.
Stupidest logic ever: Because the gov't says we have to wear seatbelts, then additional regulation is justified."

Okay, you're just ranting, you're not supporting your arguments. Lots of other commenters have been expressing the same, but have been articulate why Scott's spitball is in the end not such a practical idea and is another government attempt to curtail freedom and would lead to more needless bureaucracy.

First, let's thank God we didn't allow George W. Bush to invest the Social Security fund into the stock market.
Ready? I knew that one would take awhile ... I burned enough candles, people thought it was birthday.
Next, the free market is based on the illusion of trust. Anytime that illusion is broken, people get the heebeegeebees and pull out faster than ( fill in your own graphic metaphor ). We had regulations to help guarantee that trust, but then people got greedy, got the regulations struck down, one by one, overlooked, etc., and now the market swings back and forth wildly like a tetherball in a F5 tornado, banks won't lend money to each other, let alone even people with good credit even when the government gave them bailout money to do exactly that, and nobody is spending money on anything except absolute essentials, while we're bogged down in an execrable foreign war. Sounds like 1974, not 1931 - I know, I was there both times, whippersnappers. To instill trust, the perps have to be investigated, indicted, convicted, the regulations have to be re-instated, reliable people have to be in charge overseeing the changeover, no bailout of large corporations at all - let them sink or swim, someone will be around to pick up the pieces if they fail, give the citizens a lollipop of some kind ( i.e. a moratorium on foreclosures, a government jobs program, rebuild infrastructure ) that really means nothing, but Joe Citizen will lap up, and instill confidence.

Why punish individual investors and speculators? They would have acted exactly the same with or without licenses to invest. Index funds are great for people who are too stupid to understand how to invest in the market, too poor to buy individual stocks, too lazy to take the time, etcetera. This is perfect time for people to stop spending and learn to save but save wisely, learn to eat and live a healthy lifestyle and buy sensible life insurance. Then when you're an old coot like me, you can cash it in, and enjoy your money.

Also: this blogging software is terrible. The software shouldn't log out while you're in the middle of writing a long post, so when you enter and post your comment, it's lost and irretrievable. What is the purpose of such a feature:none at all, except aggravation.
+1 Rank Up Rank Down
Dec 22, 2008
index-tracking funds also cause the system to have problems. if a minority of money is trying to track an index whose behaviour is governed by non-tracking activities then all is good. if the tracking money starts to dominate then the feedback effects cause the index to be hard to track and it can also cause excess volatility.

the index is only a good investment because the majority of money invested has done research and is seeking a good return. if a large chunk of invested money becomes "dumb" then simply entering the index becomes a goal for corporations, rather than generating good returns.
+1 Rank Up Rank Down
Dec 21, 2008
Citizens investing in individual stocks did not cause the financial crisis, professional bankers did. You are right that a better regulation could have prevented this mess, but this is not a good example.

On another note: to all your commenters who still believe that less government is better, I propose to have a look at the the latest country that is currently completely without government and should therefore be flourishing:


O.K., I guess the pirates are doing allright.
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