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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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Dec 21, 2008
How would this have prevented the current recession? The Subprime Mess (tm) wasn't caused by inexperienced investors, it was created by bankers and traders ... arguably the most 'seasoned' investors of all. Go back 10 years and it was the same story with Long Term Capital - they were run by Nobel freakin laureates, but that didn't stop them from losing the GDP of Eastern Europe.

The actual issue is the Principal Agent problem, a well-understood source of market failure: http://en.wikipedia.org/wiki/Principal_agent_problem. Why should a CEO be concerned about his company's 10-year performance when he can personally make $1 billion in the short term? I sure wouldn't be.

I think an interesting solution would be to legislatively limit the maximum *short-term* compensation that can be paid to top-level executives (say $1 million a year - no need for them to stop being rich, after all) and require that all further bonuses be directly tied to the 10-year performance of the company. Give them stock options that don't vest for 10 years, for example. This would align the interests of management and general shareholders, and would eliminate CEO's incentive to profit-take at the expense of a company's long-term health
 
 
Dec 21, 2008
Once you ask yourself why people should be allowed to make stock decisions, you then have to ask why people should be allowed to choose a government. In both cases people make bad choices - can you really trust people with democracy when they have shown that they screw it up periodically? (Sarcasm alert!)
 
 
Dec 21, 2008
The problem with index funds and ETFs is they reward the overvalued stocks. Buying the S&P 500 you're buying CRM at over 100 P/E, over 300 future P/E. You're getting in equal shares to companies that own massive resources in the ground like AA with a 4 P/E.
 
 
Dec 21, 2008
Ridiculous. Individual ownership of stocks makes a of sense compared to most other things people do. What you should need a license for is a credit card, a car loan, or a mortgage. People that don't understand compounding interest and can't pass a simple math test should not be given credit.
 
 
+1 Rank Up Rank Down
Dec 21, 2008
The only flaw is your analysis which I can pick is that ti has been never illegal or banned to allow people to blow money or spend it like crazy. Do not compare stock market investing with professions like medicine or architecture, compare it with buying analgesics and taking vacations. If, for argument sake, people are able to buy viagra or gamble in Vegas or get breast enhancements or get hair implants, or even get married, they can as well as be free to invest in stocks, even if it is a sure shot way to disaster.
 
 
Dec 21, 2008
I have such a bloody good Idea that anyone who reads it will die from it's awesomeness.

If "even the most seasoned investment professionals running mutual funds perform worse than the indexes on average", then why not just INVEST IN THE 'INDEXES ON AVERAGE'??

A mutual fund could easily be converted to exactly reflect these 'indexes on average'.

It's so smart that I bet you all wish it was your idea. Now you will all cry as I laugh for having such a brilliant idea.
This idea is so good that I should be paid a million dollars for it, and don't dump that cheap Zimbabwean T.P. on me.
 
 
Dec 21, 2008
phillro wrote: "... and does nobody else think that a world in which investment was planned would be a better place, if only we could be better at planning? The market discounts bad ideas after they are proven disastrous. Wouldn't it be great if we could, for instance, plan services that are self-sufficient before we rape all the world's energy reserves, or plan the eating of fish before we denude the oceans, etc., etc."

I've been living in planned economy first 16 years of my life. The result WAS disaster of whole economy, not only of individual companies.
 
 
Dec 21, 2008
I was wondering if we can come up with "robots" instead of real people, who would sit for several hours, and based on some instincts (call it robot instincts), invest the money we give, themselves. It wouldn't be much different, than how it fluctuates today.. .even the great economists are unable to predict anything, anyways! What say, Scott?
 
 
+5 Rank Up Rank Down
Dec 20, 2008
Scott, you have really gone off the deep end. If no one is investing in individual stocks, then there is no one to determine prices for individual stocks, and hence, no price for an ETF or index fund either.

But your logic has a far deeper problem. "We the people" are apparently too stupid to invest in stocks, or select our own health care, or decide whether or not to wear a seat belt. But inexplicably, we are smart enough to select a few people, from a rather corrupt pool, to make the decisions for us?

You want Congress, which hasn't had balanced *SPENDING* (not a budget) in my lifetime, to decide how to spend money?

The SEC has admitted that they were warned **REPEATEDLY**, by many different people, about the Madoff ponzi scheme. Some people say the SEC is corrupt and didnt want to prosecute their crony friend, while others suggest it was simple government employee laziness... but there is no disagreement that the SEC was fully aware of the problem during both the Clinton administration AND the Bush administration. Neither did anything. These are the people you propose entrusting the markets to?

Many economists say a partial cause of the current economic collapse was the inappropriately low interest rates set by Alan Greenspan when he ran the Federal Reserve. Greenspan's blunders were exacerbated by efforts of current members of Congress to force FNMA and FHLMC to lend to borrowers who could not afford to buy. How do you figure this rampant government central economic planning is a failure of capitalism?

I am not arguing that some combination of ineptitude and/or fraud on Wall Street wasn't also a cause. I am simply arguing that greed, gluttony and vanity are human traits that extend to government just as much as Wall Street.

Any concentration of power-- Wall Street or Washington-- produces the same results. Much of the reason the private sector had so much power in recent years was the complete disaster that government planning caused in the 1960s and 1970s. Reagan got massive popular votes (from Democrats and Republicans) arguing that government wasn't the answer, it was the problem. People advocating the supposed omnipotence of government have very short memories.

Decisions on euthanasia or abortion are complicated enough when made by family members who know the persons involved -- you think having a bunch of DMV bureaucrats is going to improve things? Can you site a single piece of evidence that bureaucrats will make better decisions or give better advice than doctors?


Democrats need to ask themselves if they trust George Bush to make life or death decisions for them -- because at some point during your life, he (or someone like him) will be in office.

Republicans need to ask if they trust Bill Clinton to make life or death decisions for them -- because sooner or later, someone like him will be in office (possibly next month?)

There is no doubt the current situation has a lot of problems, but lets not go and make a bad situation worse.
 
 
Dec 20, 2008
If people should be stopped from doing things that harm themselves, then diet is a far more important area than finance - people kill themselves decades early, which is much worse than lagging the averages. So if buying individual stocks is outlawed, why not fast food?
 
 
Dec 20, 2008
People are allowed to do all sorts of risky things - bungee jump, fly airplanes they build themselves, etc. How do we decide what things are proper for the government to interfere with?
 
 
Dec 20, 2008
... and does nobody else think that a world in which investment was planned would be a better place, if only we could be better at planning? The market discounts bad ideas after they are proven disastrous. Wouldn't it be great if we could, for instance, plan services that are self-sufficient before we rape all the world's energy reserves, or plan the eating of fish before we denude the oceans, etc., etc.
 
 
+1 Rank Up Rank Down
Dec 20, 2008
"How is investing in individual stocks different than starting your own business?"

Starting your own business means taking a risk on an idea/service/product that you think is going to be better than other things already available. Putting money into shares means taking the risk on someone else's idea.
 
 
+3 Rank Up Rank Down
Dec 20, 2008
If you remove the ability of individuals to invest in the components of the index, what exactly is going to drive the index itself?
 
 
+1 Rank Up Rank Down
Dec 20, 2008
Scott,

Your idea that in-duh-viduals can only invest in ETFs or index funds carries a few implications that I'm not sure I agree with:

1) Investing in index funds are the best way to invest - I'm familiar with Bogle's argument and average annual performance over the past 30 years (for which index funds have existed)...let's discuss this again in 50 years after all the boomers retire. The 2nd point is actually more important.

2) Professionals (those allowed to buy and sell individual stocks) know what they're doing.

You probably believe that your surgeon knows more and is better about cutting people open than you do, and you might even believe that your manicurist knows more and is better than you at doing your nails... do you really believe that a licensed financial professional could know any more than anyone else, and is better than you? Licensed financial professionals obviously made mistakes by investing lots of money - including their own - in diseased livestock (aggregated, of course, to make the risk go away). As your mutual fund example further illustrates, they may be as faillable as anyone else. So who would be qualified to be licensed to buy & sell individual stocks? Assuming no one is qualified, how would the indexes be generated?

 
 
+1 Rank Up Rank Down
Dec 20, 2008
Do you seriously think it's not common for people to gamble their retirement money on blackjack? That's one of the dumbest things you've written here.
 
 
Dec 20, 2008
Investing into stock companies is one of basic economic freedom. And I think that everybody going to invest money can be aware about associated risc - all the books on investing and evan all press releases incorporate such warning. It is the same as with smoking - everybody knows associated risks and should be responsible for possible consequences.

Myself, I started invest on NYSE on August. Till now, I lost (not-ralized yet) about $3000 from invested $17000. I regard it as good result (and also as practical course on investing) regarding current economic situation, and I want to invest more as stocks are realy very cheap now.
 
 
-1 Rank Up Rank Down
Dec 20, 2008
"your odds of beating the index averages are slim. It is nothing more than gambling."

You have put your finger on what is wrong. Because we are so bad at planning economies, and because there are enough powerful people who benefit from rigged gambling in the market, we allow ourselves to be convinced that gambling is some sort of exalted freedom, and cite misunderstanding of Darwin and suchlike to justify this bizarre belief. The truth is - we should learn to plan better. That does require our planners to be trustworthy. Any ideas on how to achieve that? - one idea that didn't work so well was to subject them to the dictatorship of the proletariat.
 
 
0 Rank Up Rank Down
Dec 20, 2008
The restrictions on individuals buying stocks should be limited to 401Ks, IRAs, and privatization of 1-2% of our Social Security and Medicare contributions. That would allow individual investors to get the equity rate of return (2 to 10% per year for 30 year periods), and would reduce the number of destitute elderly that will use their voting power to force the rest of society to make up for their inept investing skills. The restrictions should limit 401K, etc. investors to bonds and broad index ETFs with a maximum equity allocation that decreases with age (i.e. you can put 80% of your 401K into stocks when you're 20, but only 20% when you're 80).

Once you've maxed out your 401K you can gamble in individual stocks all you want.
 
 
Dec 19, 2008
Hi, everybody
"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."
<a href="Make Money.htm">http://makemoney.bizoppjunction.com</a>.
 
 
 
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