How Not To Get Taken To The Cleaners On Wall Street

How Not To Get Taken To The

Cleaners On Wall Street

An analysis of Henry Blodget’s book, The Wall

Street Self-Defense Manual: A Consumer’s

Guide to Intelligent Investing

MGMT 425

Dept. of Business

Early on in Henry Blodget’s book, The Wall Street Self-Defense Manual: A Consumer’s Guide To Intelligent Investing, and actually in the first sentence, he sums up how to make money in the stock market. This is the real secret (along with another one explained later). He says, “Start early and invest as much as you can”. Now, this isn’t exactly earth shattering and most people would say, “Heck, I already know that, I think” and put the book back on the shelf at the bookstore, but it is something that most investors, i.e. “everyday people” with a 401(k) or IRA, who want to have money after retirement, don’t ever consider. Sure, we think about it every now and then, especially when we see the stock market marching forward and up, but we tend to always think that there is plenty of time to save or that in a year or two we’ll have more money and then the real saving for retirement will begin. Well, according to Blodget, who by the way was once the most respected and listened to stock analyst on the planet before the big bust of 2001 and now shuns the practice, you better get on your horse now, because with every year that passes, and with every unintelligent, uninformed, and high-cost investment that you make, you’re costing yourself potentially millions of dollars over the next forty to fifty years. The cause of these missed millions? They’re what this book is about. They’re what Blodget focuses on in the 256 pages of his self-defense manual, his consumer’s guide to intelligent investing. What are they? Time, lack of diversification, and costs: the only things that we as investors really have any control over.

Blodget is very clear on many points, but he stresses one point over and over in the book. It’s a point that he believes one has to really understand before you can begin to see positive returns from your invested money. He says that nobody, and he means nobody knows what the stock market is going to do. One of the biggest lies of all time, a lie that has been shoved down our throats (just turn on CNBC or MSNBC), is that there are people out there who know what a single stock, or for that matter the whole market, is going to do in the near future. Nobody knows this. At best it’s a crap shoot. Consider the fact that a stock can do only one of two things. It can go up or it can go down. A 50-50 chance of guessing right each time. The market is binary. It’s a coin flip. One person in a thousand will guess the flip of a coin ten times in a row. Doing so it would seem that this person has some kind of magic, predictive powers. But not really. He’s just lucky. The same with so-called “investment gurus”. If he or she beats the market two years in a row, which is an extremely short period of time, then this person is deemed someone who you should listen to, when actually they just got lucky.

So what is an intelligent investor to do? Well, first stop listening to the TV or your friends or yes, your financial advisor who, by the way, doesn’t exactly have your best interests in mind. Just because someone is making a good return in the short-run doesn’t mean they’re a financial whiz. It just means they’re lucky. Second, stop trying to pick individual stocks. There is just too much speculation involved. Investing in individual stocks, unless you’re Warren Buffett, will most assuredly not make you rich. Not in the long-run. And thirdly, remember that the biggest risk to your investment return is you. According to Blodget, intelligent investing is boring. How fun is it to put your money in a low-cost index fund and just let it sit there when everyday on CNBC, reporter after reporter is telling you about the new hot stock that’s going to go through the roof and make you rich? Makes you think you’re missing out on something.

There is very little risk in intelligent investing and we, being human, like to take risks. Some more than others. Everybody knows that where there is a bigger risk, there is the potential for a bigger return. The flipside is that there is also the potential for a greater loss. Blodget refers to this as “entertainment cost”, which is the difference between investing and speculating. A person who takes large risks is a speculator. Think gold and junk bonds, or even individual stocks. But a person who reduces their risks to a level that is comfortable to them is an investor. Think low-cost mutual funds and index funds. This latter investment vehicle, an index fund, is what Blodget stresses as the single most intelligent thing you can invest your money in. He uses the bulk of the book to make his extremely focused and lucid point that if you’ve got your money invested in mutual funds and you don’t know the costs (see advisory fees) associated with those funds, then you are investing unintelligently and are costing yourself millions of dollars over your lifetime. And yes, he has the numbers to back it up, which any first year Finance student could calculate.

First, though, is the second secret to intelligent investing. Blodget says that this secret is not news and it won’t fill you with excitement. Nor will it make you feel like a market wizard. It won’t make you rich quick or solve your money problems or relieve you of the need to save. It also won’t impress your friends or make you the toast of cocktail parties. It will, however, make you a lot of money. Here it is:

Diversify your assets, reduce your costs, and get out of the way.

Why is this true? Because the market odds are in your favor. It’s like a casino. If you play long enough, you will lose because the odds are not in your favor. In the financial markets,