Five reasons why the investment industry can hurt some investors

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Being Aware of These Issues Can Save You Money and Avoid Panic

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A bear market invariably leads investors to say things like “the whole market is a scam” or “the only people who get rich are the brokers”.

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It is, of course, human psychology to blame others when things don’t go as planned. We are not going to change that. But the market is not a scam, and such statements appall us. People who believe the scam line are doing themselves a disservice and will probably never get rich. But that’s the subject of a future column.

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Today, we would certainly agree that the market and the investment industry itself are far from perfect — sometimes very far. Let’s look at five reasons why the investment industry can hurt some investors. Being aware of these issues can save you money, prevent panic, or at least educate you on what you should be doing rather than what you have been doing.

Too focused on the short term

All eyes of investors were on exactly one data point this week: the consumer price index (inflation) in the United States. Next, everyone will move on to corporate earnings reports. Of course, these are important when looking at the market, but one economic figure – or a quarter of earnings – should not form the basis of your entire investment portfolio.

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We know many investors who will sell a business after a bad quarter. But the best companies play the long game: focus on long-term gains, or even spend more money in the short term to get there.

If you own a stock, you should aim for a holding period of at least five years: you want that capitalization to work for you. Looking so closely and reacting to a period of 90 days out of 1,825 days (not counting leap years) is probably doing your wallet a huge disservice.

The fees are too high

We could easily be talking about advisor fees here, or the preferred scapegoat, mutual fund expense ratios. But we are going to talk about investment bankers, IPOs and structured products.

How much do you think investment firms get paid to sell a hot IPO? Typically, investment bankers get 3-5% on a transaction. Think about it: on a $2 billion IPO, the bankers can make $100 million. On popular trades, clients are asking for an allocation of shares, so it’s not like it’s hard work to sell the shares. Yes, a lot of work is needed before a company goes public. But $100 million? For my life, I can’t understand why the competition hasn’t lowered these fees.

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The same comments would apply to closed-end fund financings, structured products, and regular equity sales (non-IPO), although the fees are not as high in the latter cases. Guess who pays these high fees? You make through your investments when companies have less capital after providing investment bankers with their cushy lifestyle. Seeing investment bankers driving around in Lamborghinis as we head into a recession doesn’t help the image of the investment industry at all.

Too much attention to macro issues

This year has been a challenge for stock pickers because companies don’t matter anymore. It’s all about inflation, interest rates and geopolitical events. There are debt-free companies with high margins and growth rates in the 70% range, but their stocks are half or even less than they were seven months ago.

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Everyone cares about the macro image and no one cares about business. But guess what? You own part of a company when you buy its shares. You don’t own the gross domestic product. You don’t own inflation. You don’t own an interest rate. You are a business owner. Many businesses will continue to grow and prosper despite the bad economic news. Remember what you actually own.

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Lower commissions are bad for you

After being launched in the United States, free stock trading has now started to grow in Canada. But are $0 trading fees good for investors? Well, contrary to our comment above about fees in general, we think free commissions are bad for investors.

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Zero commissions encourage trading, and trading can seriously hurt your long-term returns. Low-cost trading pushes you to react rather than invest. You are more likely to sell on a single piece of bad news and more likely to make a 10% short-term profit rather than a 1000% profit through longer-term capitalization.

Too much emphasis on stories

Over the past two years, there have been tons of media exposure on a few companies and industries, such as GameStop Corp., AMC Entertainment Holdings Inc., the electric vehicle industry, the cryptocurrency industry, and special purpose acquisition companies (SPAC). The media loves these sectors, they generate interest from investors and exchanges, and drive a lot of FOMO among investors. But, really, are they so important?

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GameStop is a US$10 billion company in a declining industry. AMC is $8 billion. They hardly matter in the big picture of the investment world. But together, they represent more news than most large companies can ever hope to realize. We ran GameStop through Google and got 143 million hits. We also ran AbbVie Inc., a $270 billion company (27 times bigger than GameStop) and got just 32 million hits. Investors need to put a lot more emphasis on big companies that matter rather than small companies that grab the headlines.

Peter Hodson, CFA, is Founder and Head of Research at 5i Research Inc., an independent investment research network that helps self-directed investors achieve their investment goals. He is also a portfolio manager for the i2i Long/Short US Equity Fund. (5i research does not own Canadian stocks. i2i Long/Short Fund may hold non-Canadian stocks mentioned.)

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