Unfair markets: Another reason to own index funds
Wall Street is rigged. Investment banks get filthy rich while sucking profits away from the mutual funds and pension funds that that you and I depend on. It’s deeply unfair but not illegal (or mostly not).
When the average investor reads yet another story about the amoral, killer scrum that’s America’s financial industry, the tendency is to turn away. You know they’re fleecing you in ways that you can’t see. But if you retreat to the so-called safety of certificates of deposit, the terrorists win. Your anger has kept you out of a game you have to play.
What got me thinking about how to deal with unfair markets was several stories that recently burst into the news. High speed supercomputers, run by algorithms, can now trade 200,000 shares in 10 milliseconds. Institutions can buy market-moving news, such as changes in consumer sentiment indexes, before it’s given to the general public. “Expert network firms” pay Senate, Congressional and U.S agency staffers to blab to wily professionals about upcoming laws and regulations that will affect the prospects of certain companies.
You can’t beat them and can’t join them, because you (and I) are just hard-working Joes (and Jills) hoping to tuck something away for retirement. The bankers run the world and extract their toll. But you and I can join them indirectly by owning index mutual funds.
Take an index fund invested in, say, the entire Standard & Poor’s Index. It owns many of the stocks that those Congressional staffers are whispering about and that the supercomputers trade. Index investors can’t get ahead of the whisperers or the Darth Vader machines. (High-speed trading now accounts for up to 70 percent of the volume on the New York Stock Exchange). But you don’t fall too far behind them, either. Whenever they mess with the market, you ride along.
It’s not a perfect ride. We do fall a little behind. That’s because the supercomputers sniff out, instantly, when a big institution such as a mutual fund or pension fund starts to buy or sell a particular stock or bond. In milliseconds, they rush in to buy or sell the same securities, getting slightly better prices (maybe by just 0.001 percent) than the slower-moving institutions do. That trades away some of the profits that otherwise would go to you.
Still, in unfair markets, it’s even harder to try to pick individual stocks. Index funds copy all the insider-rigged prices in all the stocks, making them the Joe’s and Jill’s best shot.