The Finance Industry Works Against Most Investors

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People working in Finance get paid primarily for what they do, not how effectively they do it. Traditionally, this is in the form of upfront fees and commissions, regardless of the outcome for investors. Investment banking and underwriting make even more money for bankers long before the ultimate success or failure of the transaction is known.

Most individual investors should never invest in individual stocks or touch IPOs – but brokers are incentivised to promote excessive trading, sell high-commission funds, promote their new stock issuances and make money from both sides. I am not saying bankers are evil – in the end, there is nothing wrong with providing services and charging a fee. Accountants, doctors, lawyers and other professionals are paid this away, and their compensation doesn’t depend on the outcome of their services. The point is just that clients should be aware of the motivations of the people they transact business with because upfront fees create a bias towards more transactions.

Today, the IPO market is where hopes and dreams are capitalised at high multiples: gone are the days when a new issue was a collaborative effort to connect business with prospects short of capital with investors long of capital but lacking better ideas. Now, most IPOs fail from an investor perspective: overprices or ill-conceived, too much shuffling of assets through financial engineering rather than financing the business’s internal growth. Just ask yourself: how can you fare well when a savvy issuer and greedy investment bank are of the opposite side of the table of the IPO you want to buy? They have the superiority in information, control in timing, pricing, and allocation! It is all stacked against the prospective investors!

Heard of junk bonds, sub-prime mortgage-backed securities, closed-end funds, warrants, structured notes, and, most recently, SPACs? Just remember: innovations are just good for bankers but bad for clients. In most case, they address only the needs of Wall Street, that is, higher fees and commissions. What appears new and improved today may prove flawed or even toxic tomorrow. When it comes to investing, please keep it simple. Complexity only serves the service industry, not you as an individual.

It is hard to look beyond the next transaction when the current one is very profitable, regardless of its merit. Some people work in finance solely to earn a lot of money, expecting to retire young after a few years. Others, doubting their own success, are unwilling to forego short-term compensation for long-term income that may never arrive. The compensation numbers are so large that even a few good years on Wall Street can make a person financially independent for life. Notwithstanding, a minority of finance people have maintained a long-term perspective. Some firms, like Vanguard and other partnerships, have done a good job in motivating their employees to think past the current transaction. However, for many, the financial succes of clients is a secondary consideration; short-term maximization of their own income is the primary goal.

Being always bullish generates more business than communicating pessimistic views. Perhaps this is because potentially anyone with money can buy the stock, but only the stock owners can sell. Also, if the companies you research are corporate finance clients of your firm, you have the risk of even losing business by issuing a negative ordeal. Investors like rising stock prices. Management sees higher stock prices as a confirmation of their value creation (and enjoy the increase in the value of their stock options). Companies with a high share price have financial flexibility through the ability to issue new capital. Regulators love rising markets: investor confidence is rising, which is the ultimate goal. Any downturn, according to the regulatory mentality, should be free of panic (disorderly rising markets are not a problem at all).  

Wall Street lives and feeds on fads. A boom in the insurance of securities for a particular industry can be lucrative for bankers. We have gone through several industry hypes: technology, biotechnology, gambling, home shopping, defence, Latin American stocks, Eastern Europe Stocks, Thailand, Japan, Taiwan, gold, Korea, China, commodities, internet, cryptocurrencies, Clean Energy, SPACs, EVs, and AI now. A boom in the issuance of stock in a specific industry is very lucrative for the initiators: advisory fees, IPOs, funds, exits of private equity funds and founders, debt, and generating profits long after the enthusiasm wanes. All market fads come to an end. Eventually, security prices become too high, the top is reached, and the painful downward slide starts. There will always be cycles of investment fashion and, just as indeed, investors who are susceptible to them.       

Financial markets are dangerous for investors, but you have no choice but to do business there. The standard behaviour of every counterparty is to pursue maximisation of self-interest, usually in the short term. Investors must acknowledge, accept and deal with it. If you keep this in mind for every transaction, you can prosper. Investment success may remain elusive if you depend on bankers to help you. 

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