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.

Rank Up Rank Down Votes:  +4
  • Print
  • Share


Sort By:
+2 Rank Up Rank Down
Dec 19, 2008
But Scott, what if the reason that indices outperform managed funds has to do with the relatively small portion of investment that bets on the indices? Some would argue that the indices outperform because they effectively aggregate more information. If everyone were in indices, they wouldn't aggregate much information, and thus be susceptible to wilder swings. Think of the funds popularized by Vanguard as information arbitrage. If suddenly everyone is playing that game because it's illegal to play individual stocks, it loses its comparative advantage.
Dec 19, 2008
"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."

You seem to suggest that only people with insider knowledge should invest directly in the stock markets. But insider trading is illegal. Therefore nobody should invest in the stock markets. Close down the stock markets!!

On another note:
The aim of investing in stocks is not to beat the long term market averages, but to beat the returns obtainable from other avenues of investment.
Dec 19, 2008
"My argument against allowing individuals to invest in stocks is ... it is nothing more than gambling."

I can invest in a dozen high quality blue chip stocks, the GE's, Microsofts, Lockheed Martins of the world, putting 1/12 of my money in each, and do very well over a career of investing. With steady dividends and long term growth, this doesn't even resemble gambling.

"The myth of stock investing is that a person who does more research has better results."

Tell this to Warren Buffett.

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

While it may or may not be common now, there is nothing stopping someone now from emptying their IRA and 401k, paying the early withdrawal penalty, and heading over to Vegas. Prudence is what stops people from doing it.

You claim to be a libertarian (without the crazy stuff). So why does it seem all your ideas/posts treat people like they're idiots?

Dec 19, 2008
You are dead on about investments or speculation in the stock market being a loosing game. Looking at the practice of stock market gaming from a different point of view is instructive.

You as the investor are basically loaning money to a company by purchasing shares with the hope of a return of the investment plus additional financial rewards for doing so. If treated as a loan, which it is, there are several things that the borrower, the company, is telling you will happen to your investment:

First, they do not have to pay back the principle money you gave them, ever. Two, they will decide when and how much they will pay you as a return on your investment in dividends. In other words they decide your interest earned, if any. Three, they have no obligation to invest the funds you provided intelligently or prudently and can blow them anyway the want. Four, you have no say so in company daily operations.

Five, you are overwhelmingly out voted on the overall direction or course the company sets for itself. Six, the company even has a right to file for bankruptcy, suspend operations, change management, overpay management, drastically downsize, sell off assets, merge with other companies or simply go out of business. Seven, you have no claim on any liquidation of assets of the company if it fails. Eight, if they split their stock you are receiving shares that also are subject to all of the above. And finally the stock broker that put you into this loan for a fee has zero liability if you loose your money.

The only way to win here is if you can find some other sucker to buy you out for more than you paid. But you are putting that poor soul in the same position of loosing their money as you did in the beginning. So much for helping out your fellow man.

So the company you are considering investing in can be as greedy, arrogant, stupid, careless and free with your hard earned money as they want and you can not do a thing about it. They are basically saying, hey stupid, if you want to loan us money fine, but do not expect us to give a rat fink about it or you once you hand it over to us. Now that is some stacked deck. Would any one in their right mind make that kind of loan with no collateral? Yep, many of us do it all the time. Go figure.
Dec 19, 2008
Some Moist Robot

Reread the post and then go away humbled after you realize you're an idiot.
Dec 19, 2008
To extend your argument, almost no actively managed mutual funds routinely beat the indexes. Therefore no professional brokers should be allowed to buy individual stocks?

But the whole purpose of the stock market is to provide liquidity for individual stocks.

If EVERYONE bought only index funds, the whole system would break down.
Dec 19, 2008
There are a few basic principles and methods you can use to make money investing in stocks. They have been proven by over a half-dozen investors over the past six decades or so. Warren Buffett wrote about it The Super-Investors of Graham-and-Doddsville.
Dec 19, 2008
On an incidental point, your guess was wrong about the reason for the legality of gambling. "Problem gambling" is surprisingly common, and frequently involves betting yourself into bankruptcy and even stealing from friends in an attempt to 'win it all back'. Basically, it's as addictive to some people as hard drugs. I think it might be a brain chemistry thing, but I'm not sure.

The gaming industry in Australia gains about a third of its revenue from gambling addicts. A study I just pulled off Google suggested it may be about half that in America. Still, I'd call that "common". And it's not illegal because of the massive profits that can be made from these people, and a general libertarian attitude that it's their own problem. An attitude I shared by default until I saw how involuntary it could be for some people. And how devastating.

Dec 19, 2008

The story at the above-referenced link shows that Google accurately predicted a flu outbreak two weeks ahead of the Center for Disease Control (CDC). It was done by watching the number of searches on "flu" or flu symptoms.

Given that, and Scott's recent blog post (which I cannot seem to post a comment to) on "Google is my doctor" there might be a way for Google to predict the "bottom" of the stock market. As we have seen, none of the "experts" can tell you when the stock market will reach the bottom, due to bias, malice or incompetence, but is there a common search term like "stocks" or "Bargain stocks" that would be a precursor to a stock market buying spree that would serve to start raising stock prices again?

Think about it.
Dec 19, 2008
ETFs only work if a small number of people invest in them, and count on the market mainly being made by people who invest based on rational economic principles (I know -- that doesn't really happen; I'm talking theory here). If everyone buys ETFs, investment decisions are made by the people choosing the stocks that go into the index, who may or may not be more savvy than the rest of us, and the market will be determined solely by how much people are willing to pay for the ETFs, not at all on basic value.

Dec 19, 2008
Any rules for investing will always result in "legal" ways to either bypass the rules, or break them without seeming to break them.

ETFs are a good example. Is used to be that in order to invest in the "enitre" market, such as the Dow or the S&P500, you would have be quite wealthy already, in order to buy shares in all the companies. Presumably if you had sufficient wealth, you could afford the risk.

Now, you can buy the entire S&P500 by buying a single SPDR share.

If you had a rule restricting direct participation in the stock market to a minimum investment of $500,000, people would get around it with mutual funds.

Some people have found that their investment was with Madoff's hedge fund. They had no idea they were invested in it because they gave their money to a different fund manager, who invested in other funds, and those other funds had invested in Madoff's funds.

Buying in the stock market is a gamble. Buying an ETF is like betting on all the horses in 1 race. You will win, but not very much. And if everyone did the same thing, then betting on the race becomes pointless.
+1 Rank Up Rank Down
Dec 19, 2008
There are already plenty of limits on investing. Certain types of investments are only open to people with very high net worths.

Despite the fact that gambling is "inteded" as entertainment, most gamblers do not treat it as such. Most people gamble to win. If they did not, Las Vegas would not be what it is today. The same is true of investments. Most people feel that they can beat the indexes. Can they? Of course! Some stocks _will_ do better than others and the people who invest more heavily in them do better. It is ALWAYS part luck and SOMETIMES part skill. Just like poker.

Dec 19, 2008
if it's illegal to commit suicide, and you try&succeed .. (1) can your corpse be arrested? (2) if you're tried&convicted post-mortem, can you be punished? (3) what would be a suitable punishment? (I favor being made to go to Congress)
0 Rank Up Rank Down
Dec 19, 2008
Seriously. Watch. http://www.youtube.com/watch?v=OF87sMjYlws
Do you think he has it right on the nose?
Dec 19, 2008
Use to be the best research method was your on experience. The idea was, you should invest in companies which produced things you actually used/enjoyed.

I'm not sure that is the best advice anymore. The best advice might be to avoid the stock market altogether.

Since the early 90's when 'day-trading' became popular, I think publically held companies have lost sight of long-term planning. Nowadays 'long-term' planning is what are we doing next week. Use to be companies made plans for what would make them successful 5-10 years down the road and didn't pay any attention to their stock market price (that was the investers concern). Now if a company's stock price falls 10% one day, then something has to be done, NOW!! Publically held companies don't plan for success anymore, they react to the market.

It never ceases to amaze me that when a successfully run privately held company goes public, the first thing that changes is that management becomes concerned with what market analyst have to say about their business. I say, keep doing what made you successful and don't worry about the market price. But that's not what happens.
0 Rank Up Rank Down
Dec 19, 2008
Where's the evidence that the recent stock bubble (or the prior tech bubble) was primarily caused by individual investors? The amount they invest, and their ability to influence stock prices, pales in comparison to institutional investors (mutual funds, pension funds, insurance companies, college endowments, etc.)

For the records, we DO allow people to practice medicine, law, or build houses when they're only doing so for themselves. You can represent yourself in court, go to the drugstore and buy some medicine for your cold, or remodel your basement without violating any laws. There's no reason you shouldn't also be able to decide what you spend your own money on.

Even if individuals were banned from investing in the stock market, institutional investment is still controlled by people who are greedy, irrational, cowardly (in other words, human). There's no reason to think they wouldn't be swept up into the next bubble, just like they got swept up into every bubble in the past.
Dec 19, 2008
At first thought, my solution would be the obligation of a note of warning before any stock purchase. Same as with tobacco.


Is possible that the data you take as a basis be made up to some extent AND key, nevertheless obvious, point: There is no way you can be told that fact from any official source. A warning would correct that gap.

Furthermore, I believe that if you are properly endowed, rare as it might be, you can make a decent return consistently over time.

Finally remember that we don't lose any money at all by the wild swings of the market, which is just an opinion, we lose money if the company does bad in the future and if we are buying high, period. Is it really SO difficult to avoid that? Can investing with that very basic knowledge lead you to major loses in the future? I don't think so for the most part.
-1 Rank Up Rank Down
Dec 19, 2008
It's actually a really good idea and we should do it.

The problem with leaving people to create their own financial disaster is that if even the experts can't gamble well, then most people will totally fail.

And the state can't let *most people* starve to dealth in their old age.

So the choice is more stark. Do I personally want to fund the retirement of people who make stupid investment decisions or do I want to keep my money and simply not let them make those decisions.

Tricky one... ;-)
Dec 19, 2008
What if economics was made as high a priority in schools as math and reading? That would cut down on the need for laws on most things, not just investment.
Dec 19, 2008
Your final paragraph is the most brilliant thing I've read in a long, long time. What's genius about it is it made sense before I understood it.
Get the new Dilbert app!
Old Dilbert Blog