Many of my friends are in the fortunate position to have stable, well-paying jobs. Several of these friends have recently come to the realization that while saving money is good, what they should really be doing is growing money â€“ not simply saving it. Along those lines, the impending social security crisis and the power of compounding are concepts most understand.
Several people in the past couple weeks have asked me what they should do with their money since simply â€˜saving it’ is inadequate. Why they ask me, I am not sure. Perhaps it’s because I have an MBA, but I am definitely not a professional investment advisor, nor economist, so only listen to what I say on such matters with a grain of salt.
My first piece of advice is to max out any 401K option offered through work, especially looking to take advantage of matching offers. In addition, I always suggest opening a Roth IRA account as an additional saving component (I like to stress that IRA’s are liquid in the sense that they allow you to take your money out if need be).
However, when I get asked about which specific stocks someone should invest in, I tend to become uncomfortable. Why I am â€˜uncomfortable’ should be a position that all young professionals understand about today’s state of economy.
It’s my belief that current equities markets are unfairly manipulated by big money. Thus the risk level involved for most of us amateurs investing in specific stocks is too high. I think such market manipulation is a real flaw in our current economic system and I personally believe it is a contributing factor to the pathetic savings rate among most Americans. You and I are at an unfair disadvantage that has nothing to do with modern portfolio theory, i.e. diversification or the efficient market hypothesis. Heck even renegade cowboy investor Jim Cramer with his â€˜can’t miss picks’ can’t beat big money manipulation. Two recent articles reinforce my opinion.
First, rouge trader Jerome Kerviel somehow managed to run up a $7.2 Billion loss on behalf of the French Bank, Societe Generale. One person. $7.2 Billion is a staggering amount of money. Put in perspective; $7 billion dollars is a million dollars seven thousand times. $7.2 Billion is as large a sum as some entire foreign economies operate on. Thus, a series of transactions moving around that large an amount of money can really shake things up in a profound (profoundly bad) manner. From the New York Times:
â€œSociÃ©tÃ© GÃ©nÃ©rale rushed to unwind those trades during Monday’s market plunge, and trading in those futures contracts soared to record levels. The bank’s abrupt reversal contributed to a decline that snowballed into an avalanche of sell orders around the world, some traders said. The ensuing turmoil helped prompt the Federal Reserve to orchestrate the surprise cut in interest rates announced Tuesday.
â€œI have little doubt that SociÃ©tÃ© GÃ©nÃ©rale’s unwinding of those positions absolutely pressured indexes worldwide,â€� said Barry L. Ritholtz, chief executive of FusionIQ, a New York-based investment research and money management firm. â€œAnd wouldn’t it be embarrassing if the Fed had to make one of the biggest emergency rate cuts ever because of some rogue trader?â€�
Well the Fed did make an emergency rate cut. And it’s not the first time in recent memory the Fed has had to some of the rescue of bad manipulation. Remember that hedge fund in Greenwich?
The next article I point to was written by one of my favorite economists, Ben Stein. Understanding the magnitude of money involved in such newsworthy events as the Societe Generale fiasco, and John Paulson’s recent score, Stein’s comments are all the more frightening:
â€œI have come to believe in the theory of what I would call â€œfinancial realism,â€� or what might more accurately be called â€œtrader realism.â€� Under this theory, on which I have an imaginary patent, traders can see masses of data any minute of any day. They can find data to support hitting the â€œbuyâ€� button or the â€œsellâ€� button. They don’t act on the basis of what seems to them the real economic situation, but on what’s in it for them.â€�
Stein on the Sub Prime Mess and recent market volatility:
â€œThey [traders] have seized upon a fairly bad situation: a stunning number of defaults and foreclosures in the subprime arena, although just a small part of the total financial picture of the United States. They have then tried â€” with the collaboration of their advance guards in the press â€” to make it seem like a total catastrophe so they could make money on their short sales. They sense an opportunity to trick other traders and poor retail slobs like you and me, and they generate data and rumor to support their positions, and to make money.â€�
And finally, Stein on the meta-economic consequences of such actions:
â€œMORE than that, they trade to support the way they want the market to go. If they are huge traders like some of the major hedge funds, they can sell massively and move the market downward, then suck in other traders who go short, and create a vacuum of fear that sucks down whatever they are selling. Note what is happening here: They are not figuring out which way the market will go. They are making the market go the direction they want.â€�
From this article you now know that 1) you should be growing your money, not simply â€˜saving it’ and 2) you know to be wary of investing in individual equities due to big money manipulation. In my next post I will suggest what strategy I would employ, as well as highlight a few industries where investing in specific stocks might make sense.
Update: Some Ben Stein criticism