In a prior post I questioned whether ignorant citizens should be allowed to gamble by buying individual stocks, as opposed to investing in an index of stocks to reduce risk. Your comments raised some interesting questions that I think are worth wrestling with.

First, many of you pointed out that capitalism depends on people having the option of buying individual stocks. That's how companies raise capital. But surely there is a better way to raise capital than by convincing idiots they know more than they do.

Suppose citizens had two ways they could invest in equities. One channel is through the general index of all stocks (not just the S&P 500). The other is a fund managed by venture capitalists along with their own money. With this system startups still get funded, but only by experts who are close to the action, and citizens are still diversified. And I could imagine some sort of percentage-of-assets limit on how much individuals could invest in venture capital funds.

If a startup succeeds, it gets rolled into the index. From that point on its stock price would move with its actual earnings, as estimated by some sort of regulating board. It wouldn't matter if the regulators got the stock price wrong one year because it would average out with other stocks, and they could always go back and adjust it on appeal from the company.

Employees of a company could still own stock in that enterprise, so they are incented to get profits up. But outsiders could not own the individual stock.

The second objection to banning individuals from owning stock is the Warren Buffett argument. The thinking is that Warren Buffett's method of investing proves that individuals can succeed by buying undervalued stocks and holding them for the long run. So since we know individuals can somewhat easily succeed at investing in stocks, it would be an unreasonable limit on freedom to prevent them from doing it.

There are a few problems with that line of thinking. First, Warren Buffett buys companies, not stocks, in the sense that his stake is so large he can influence management. And his access to information about the company is much better than yours. He's a perfect example of why an individual should NOT be buying stocks; you're competing against the likes of Warren Buffett for limited resources. In the long run, Warren Buffett will have his money and yours too. You're no Warren Buffett.

Still, there are plenty of civilian investors who have done well buying value stocks and holding for the long run. But wouldn't you expect a wide distribution of luck in any gambling arena? If every investor picked stocks entirely randomly, you would still produce a good number of Warren Buffetts entirely by chance. And our brains are wired to assume those winners had the secret formula for investing.

If Warren Buffett's success is indeed a function of following a simple philosophy of investing, and that method has been well understood for decades, you would expect most managed mutual funds to beat the averages too. They don't.
Rank Up Rank Down Votes:  0
  • Print
  • Share


Sort By:
Jan 10, 2009
The reason index funds ourperformed managed funds were more due to fees than to pure
performance. Because a 3% annual cost times 15 equal 45% over 15 years. It is also not
true that people owning individual stocks fared more poorly than indexer. More precisely,
people, like Mr. Adams, gambling on internet stocks that were pure fantasy lost lots of
money because they thought a few idiot kids in a room can put mega corporation out
of business. In fact, Mr. Adams proposal is really to ban foolishness. Which is not possible.
Also, Citibanks, AIG, et al, comprise a large portion of the Index, so being wiped out cost
you just as much as owning them. And also, owning the Indes IS owning stocks. There
is no magic bullet, and it is all a crap shoot. But there are a lot of people out there, who
invested, not speculated on a dream, and held dividend paying stocks for many years and
fared much better than any index funds out there. Mr. Adams is extrapolating the past into
a certain future that none of us is smart enough to foresee.
Jan 4, 2009
I am so tired of the current Nanny State. I want my constitutional right of life, liberty and the pursuit of happiness. If that means I want to buy individual stocks, well, so be it. I feel personal responsibility is ignored in society now. Let big daddy government make all your decisions. More and more laws to control you stinks. I have owned common stocks for decades. I have traded some. I have held some for as much as 28 years. I have made lots of money. I have lost some money, too. We get a bear market and all the rules need to be changed? Uh, no. A bear market is a great sale for those wanting to buy cheap. I don't want to be told what to do. I am a big boy and can make my own decisions. I don't cry and moan when things don't go my way. Yeah, such is life. I want to keep my freedom to make my own investing decisions. Otherwise, I may as well live in Cuba.
Dec 29, 2008
"you would expect most managed mutual funds to beat the averages too."

And in fact, exactly 50% of them do!!

Uh, if everyone was using an effective management strategy....wouldn't the average go up? And how do we know that hasn't already happened (until recently, anyhow?)
Dec 27, 2008
The only problem I can see with only allowing venture capitalists to invest in start ups is that vc's, it seems to me, only pick safe-ish bets while the really big ideas have an anoying habit of coming from people no-one would back. I could be wrong on both of those assertions (that vc's wouldn't invest in wild ideas and that big ideas come from left field whackos), but based on anecdotal evidence it does seem to be true. Of course, it takes a million crazies to get one killer app, but that doesn't mean we should stop trying.
+1 Rank Up Rank Down
Dec 26, 2008
Scott, you should read the book "Wisdom of the Crowds". I am not the author and couldn't care less if you buy it or steal a copy -- but it may help you understand the stock market much better than you do now.

Most of the time, "the crowd" produces better decisions than any expert. There are dozens of examples in the book that range from counting jelly beans in a jar to valuing a business / real estate investment.

But then the author talks about what makes the wisdom of the crowds break down -- the crowd is "wise" in most instances, but under certain !$%*!$%*!$%*! it degrades into a stupid mob.

Markets (and crowds in general) function best when many many members each make an **INDEPENDENT** decision. If the decisions are independent, the real wacko decisions cancel out, and the remaining distribution turns out to be pretty good -- better than what the experts produce.

When the decisions are not independent -- like when everyone starts blindly following the advice of the talking heads on TV that real estate prices can only go up -- you get problems. Independent thinkers would have asked how the average person could possibly pay such an outrageous price for a house when paychecks are not rising anywhere near as fast (or at all in some cases?)

Mass hysteria is not rational, but happens far more often than anyone wants to admit. What will fix the stock market (and housing market) over time is when people go back to making independent valuations. Appointing some elitist bureaucrats posing as experts would only serve to legislate mob thinking into law -- it is the exact opposite of what is needed
+1 Rank Up Rank Down
Dec 26, 2008
You are suggesting that "we" create some all powerful, all seeing entity to value a company's earnings (and I guess stock price)... you wrote "From that point on its stock price would move with its actual earnings, as estimated by some sort of regulating board."

This shows a distinct lack of research on your part. FASB (Financial Accounting Standards Board) already exists. They already regulate accounting standards. They are staffed by an army of CPAs and regulated by the SEC. But in the real world, valuing earnings (and companies) is more an art than a science.

Scott, when you bought your restaurant -- did you anticipate you would have so much difficulty filing the banquet areas? Did you not consult with accountants and lawyers and so forth before you made your investment? Are you going to argue that we need a law strictly prohibiting cartoonists from buying restaurants? Or could it be that human beings are fickle creatures who often change their minds about what is the "in thing" of the moment? If your restaurant were the "in thing", it would clearly be worth more than another restaurant that has good food but people don't flock to for whatever reason. How long would the "Dilbert Mystique" last for? How long will your restaurant remain the "in thing"? That is, at best, a matter of opinion -- and more likely a blind guess. The "experts" in the restaurant business have no clue, and if anything the man/woman on the street is more likely to know where the new "in thing" restaurant is.
+2 Rank Up Rank Down
Dec 24, 2008
Are we upset that the current philosophy of investing is so misleading, or are we embarrassed that we misunderstood (misinterpreted?) the philosophy to mean SAVING?

Do we understand what it means to "save" rather than to "invest"?

How many of us thought we were "saving" when we were really "investing"?

Did we know that saving and investing do not carry the same risk factors? Should we have known? Shouldn't we have known???

The ability to buy and sell investments has been around for hundreds of years. Why does this generation of ignorant citizens need it outlawed?
+1 Rank Up Rank Down
Dec 24, 2008
n1lul - That is a classic example of the adage, "you gotta have money to make money"! Back in the good 'ol days, Buffett and his boys actually had to work at making money, now people throw themselves on him like he is some messiah.
+1 Rank Up Rank Down
Dec 24, 2008
Bufffett just made between 300 and 500 million dollars when he bought the company I work for at a cut rate price. He had clauses in the contract saying that if we backed out he got cash and stocks. Well, another company came along with a much better offer. We canceled Warren's contract and he walked away with a bunch of money for what amounted to a 3 month loan.

Smart guy.
-1 Rank Up Rank Down
Dec 24, 2008
Regarding your first point, who would make up the board? Who is smart enough to accurately assign values to stocks? Your entire argument is pretty much that "people can't value individual stocks," so if the board is made up of people, you're still in the same situation, just with a smaller pool. And you can't say "let the entire pool be geniuses" because geniuses are just as bad as everyone else, or worse (see: Long Term Capital Management). A lot of it has to do with the fact that the value of stocks are based on future expectations, and as they say, prediction is hard (especially about the future!).

I have this piece of paper and I want to sell it to you. People who have held this piece of paper have in the past received $5 a year, but some years they've gotten only $1, some years they've received $10, and there's always a possibility that they'll receive $100 or more, but other than saying it's greater than 0% and less than 100%, no one's really sure what the chances of that happening are. So how much is that piece of paper worth? And that's just the dividend. Think of all the other variables that can go into a company's valuation...

Of course, you could say "replace the people with computers," but there are two problems there. First, the computers are built by people and reflect their flawed ideas, and second, you can see by the amount of programmed trading today that computers are really no better at valuing stocks than people are, they just change their mind faster!
Dec 24, 2008
1) Scott's proposal is premised on the assumption that the fundamental goal of investing should be security. He seems to think if we insulated individuals and the economy from really stupid losses, we would all be better off. That assumes that the overall net effect of the losing bets is not outweighed by the absolutely mind-bogglingly huge payoffs that come from successful ventures that wouldn't otherwise have been able to get off the ground without readily available investment dollars. I doubt that that's the case. I think we need the idiot investors to generate the innovation that keeps our society prosperous.

2) Why all this attention paid to individual investors in the stock market? There is a far more common way that people lose everything they own on risky ventures: starting their own business. If you try to stop people from investing everything they have into small business, you will kill the economy, end of story. Most small businesses fail miserably. And yet, small businesses employ a significant percentage of all people in the country. Again, it is the concentrated sacrifices of a few risk-takers that enables the rest of us to ride easy.

3) Being "all-in" on an investment does have some benefits . . . like inspiring confidence in other investors. Most venture capitalists want to see the principles of a company leveraged to the hilt -- completely, utterly invested in their company -- because then they know the principles will be 100% committed to the success of that venture. Committment is extremely important to success in business. Sometimes you have to burn the boats.
-1 Rank Up Rank Down
Dec 24, 2008
If people are for the most part investing in a whole-market index, everyone's portfolio would perform exactly average. Those who would want the possibility of additional growth would be required to invest in startup funds through an "expert", but here's the thing: Some startups will succeed and produce massive returns, some will fail horribly, and overall their performance will be exactly average. By eliminating risk, you also eliminate the chance of a big payoff, and kill the incentive to invest in startups.

I assume you're saying that venture capitalists need to invest your money along with their own to ensure they carry out their fiduciary responsibilities. Fair enough. But for me the most flawed assumption is that these "experts" are better equipped than the average person to invest money on your behalf.

There is no evidence that "experts" are able to consistently outperform the average; in other words, sometimes they win, and sometimes they lose. This is no different, on average, than what an individual investor would achieve.

But more importantly, if the power to invest in startups is vested in the hands of a small number of experts, that becomes a form of censorship on innovation. An investment expert may know about accounting, about financing, about derivatives and more exotic instruments, but likely knows very little about a new business model. That means innovative business don't get funding because they don't fit the mold of successful startups.

Internet search was "done" long before Google came along. How many responsible venture capitalists would have invested in such an obviously doomed idea? There's something to be said for one idiot convincing another idiot to invest in his dumb idea, because every now and again, the idiots will be laughing all the way to the bank.
-1 Rank Up Rank Down
Dec 23, 2008
and buffet stock got big because it never splits and doesn't pay out 1/3 of earnings in the form of a dividend like most other companies. simple compounding - no magic.
Dec 23, 2008
<i>But surely there is a better way to raise capital than by convincing idiots they know more than they do.</i>

No one has ever gone broke convincing the rubes that they're smart.
+1 Rank Up Rank Down
Dec 23, 2008
warren buffet doesnt do startups. a chimp can read a balance sheet, income statement and get an objective read on the viability of an average business. this was a an idiotic post. go back to commenting on yacht !$%*!$%
Dec 23, 2008
I disagree with your logic on the Warren Buffett analogy. Buffett is only one example of someone who has done well by investing in undervalued stocks and holding for the long term. He's just one well known example, who has done exceptionally well. There are LOTS of people who have done well, but you don't read about those folks in the newspapers. Sure Buffett buys companies, not stocks. But did he start out buying companies? I don't know his whole biography, but I'd imagine he started with stocks.

"You're competing against the likes of Warren Buffett for limited resources."

How many undervalued stocks are there out there? I can't count them. Neither can Buffett. Buffett is notorious for only investing in 'boring' compaines: Gillette, the WashingtonPost, etc. I don't have to compete against him! This isn't a zero-sum game!

"You're no Warren Buffett."

I don't have to be. Each person has their own investing goals. Too many people think of investing in companies as a fool-proof retirement approach. People don't realize that they're becoming part-owner of the company! Shouldn't I decide how much the share of the company is worth before buying into it? Yet if a stock is valued by some sort of regulatory board, as you propose, we'll see some *crazy* stock valuations. The idea would never work.
-1 Rank Up Rank Down
Dec 23, 2008
I dob't think he;s that great.

berk is down 15%. i dont do that bad trading my own stocks, (duh).
-1 Rank Up Rank Down
Dec 23, 2008
Phantom II - You give my scrolling finger cramps dude! Try to condense a bit next time, would you? Besides, you are flat wrong on one major point, "The key to successful investing is to buy high-quality assets, diversify, and wait" is fundamentally flawed. This is the definition of index investing, not successful investing. Successful investing implies much greater than market returns repeated over time. The magical "Warren Buffett" way is just this - he picked a few companies, he and Charlie did their homework, took major stakes and made sure they succeeded. What you describe is the casual investors formula - don't loose too much money and hope for a good year or two!

Follow Warren & Charlie's lead and do your own work, invest in a few very well run companies and watch very closely what is going on. For most, this means two or three positions until you can hire someone to properly do the due diligence on more. And Scott's idea of a license or the SECs "qualified investor" rule is a great place to keep people out of capital markets and in the casinos where they belong until they are ready to do the work necessary.
0 Rank Up Rank Down
Dec 23, 2008
Scott, There was a third argument as well, and it's supported by economic research. It says that index funds work when the percentage of investment in those funds is relatively small. Perhaps where you should really be going with this is that most people should have their retirement money in CDs or money market accounts.
+1 Rank Up Rank Down
Dec 23, 2008
Sometimes idiots with passion outperform the "experts". I read an article about a new site called KaChing http://www.kaching.com. It's based on a popular facebook app. The idea is that any idiot can create a portfolio, which is open for all to see. The app tracks the return. KaChing now allows individuals to invest with their favorite idiot based on their returns.

It's pretty amazing to see quite a few of these portfolios deliver astounding returns over the past six months which the rest of the world got pummeled. BTW, I'm have no involvement with KaChing. I'm just one of the individuals who got pummeled by being in the S&P 500 Index over the past year.

Get the new Dilbert app!
Old Dilbert Blog