The stock market is rigged against Main Street investors but that doesn’t mean you can’t make money
Over nearly a decade working with venture capital firms and providing investment analysis for wealthy clients, I saw just how rigged the stock market is against everyday investors.
It’s not exactly like Scorsese’s Wolf of Wall Street but there are definitely ways insiders and money managers cheat Main Street investors to get rich. In fact, there are three ways the stock market is rigged and there’s nothing investors can do about it.
That doesn’t mean you still can’t make money and reach your financial goals.
I’ll start with proof the stock market is rigged before showing you three key points to make money despite the unfair game on Wall Street.
Making Insider Trading Legal for the Super-Rich
Insider trading is one of the few ways to really beat the stock market. It’s where someone with information about a company, information that the public doesn’t know, uses that information to make a killing buying or selling the company’s stock.
Of course, it’s also illegal…or used to be.
With many insider trading cases, someone within a company usually tips off another investor. The investor buys the stock, makes a fortune and gives the company insider a cut of the profit. In 2014, a U.S. court overturned the conviction against a money manager and said that for insider trading to be illegal, two things needed to occur:
- The company insider had to be getting a personal benefit from giving away the information, and
- The investor trading on the information must know that the person giving the information was getting a benefit
Basically, the court’s decision totally rewrote the definition of insider-trading and made it impossible for the government to convict anyone.
This all became the stuff of a day-time soap opera last year when pro-golfer Phil Mickelson was named as a relief defendant in the government’s insider trading case against Bill Walters.
- Walters, a Las Vegas ‘business man’ was a friend of Mickelson and Thomas Davis, the chairman of Dean Foods
- In his role on the Board of Directors, Davis knew that Dean Foods would soon announce its spinoff of WhiteWave, an organic food subsidiary, and shares of Dean Foods would probably skyrocket
- Davis told Walters about the spinoff plans, prompting Walters to buy up millions in stock, and Walters later told Mickelson
- When the spinoff was announced…shares of Dean Foods surged 40% making Walters $40 million and Mickelson a cool million dollars!
Mickelson had never been a big stock investor despite making tens of millions as a golfer. He had just $250,000 in stocks and had never bought shares of Dean Foods…until he bought $2.4 million-worth after talking to Walters.
Both Mickelson and Davis owed gambling debts to Walters, who had given Davis loans of nearly $2 million. I’m guessing those debts were paid in full after the big payday everyone enjoyed on the stock.
Davis pled guilty and cooperated with the government. Bill Walters tried to get the case dismissed but it was overturned and is still pending.
The government could never prove that Mickelson knew the original source of the information or that he was receiving a personal benefit. I’m not sure about Phil but I don’t think I’d put down $2.4 million without a good idea that my investment was a sure thing.
The moral of the story is that ignorance is indeed bliss in a rigged stock market. Insiders are now able to share with their friends as long as the insider isn’t explicitly benefiting or that the investor doesn’t know the source of the information.
A Rigged Stock Market Joins the Social Media Revolution
Another way the stock market is rigged has popped up only recently. Any communication between an investing firm, it’s employees and clients or others is supposed to be kept on record for years so regulators can fight insider trading.
This regulatory oversight has become impossible in an era of encrypted social messaging on mobile apps like WhatsApp and Signal. Insiders and stock traders can send valuable information instantly to each other. Some apps even automatically erase messages after a certain amount of time or after receipt.
The U.S. recently filed an indictment against one money manager working for the $50 billion New York state pension fund. Documents allege the manager received gifts totaling almost $180,000 from two bond investors including a $17,000 watch, cocaine and prostitutes.
According to the indictment, the manager used WhatsApp to secretly feed information to the two traders who were then able to trade and make a profit.
An Unfair Market Selling Picks and Shovels
When gold discovered in California more than 150 years ago, the only people that got rich were the ones selling picks and shovels to the miners.
It seems not much has changed and an unfair market has found a way to get rich off of Main Street investors.
The problem comes with two different types of financial advisors. Registered Investment Advisors (RIAs) are regulated by the Financial Industry Regulatory Authority (FINRA) and must always keep their clients’ best interests in mind when recommending investments.
The other type of advisor, a registered broker, doesn’t have this same requirement. They have a much weaker test that their recommended investments are suitable for investors. That means they can suggest all kinds of investing products, even ones with high commissions and kickbacks to the advisor. These investment advisors are making a fortune selling investment products, the financial equivalent of picks and shovels, to investors.
These weak rules for advisors has led to widespread misconduct. A survey by the University of Chicago found that as much as 20% of the advisors to one brokerage firm have been disciplined for misconduct.
This was supposed to change with a new fiduciary rule to start 4/1/2017 where all advisors would only be able to recommend investments in their clients’ best interest. In the ultimate April Fool’s joke, the Department of Labor has delayed the rule change and it may end up getting repealed.
If you use an investment advisor, check to see if they are an RIA or a registered broker…then check those hefty fees you’re paying on investments.
How to Make Money in an Unfair Market
None of this even touches the fact that some investment firms pay to get their information before the rest of us and trade on that split-second timing in a practice called high-frequency trading.
Considering the evidence of a massively rigged stock market, investors have every right to be enraged. Is it any surprise that the richest 1% own nearly 40% of the wealth in America?
It would be tempting to avoid the stock market altogether. Why would anyone knowingly play in an unfair game but where would that leave you?
You have to invest your money. Savings accounts pay just 0.06% meaning you lose almost 2% of your money each year to inflation. Despite the fact that the stock market works best for the insiders and ultra-wealthy, it still works for the rest of us as well.
Follow these three tips for investing in a rigged stock market:
- Invest for the long-run. Stocks have returned about 8% annually over the last several decades. Most of the stock market cheats work in the very short-term but long-term investors still get a piece of higher earnings over decades.
- Invest in fixed income investments like bonds and peer loans. Bond prices trade on current interest rates and the cash flow provided by the investment. I’m not saying there aren’t shenanigans in bond trading but you know the return you get from a bond when you buy it. Peer loans through sites like Lending Club offer higher returns than bonds but more certainty than stocks.
- Invest in a market rigged to your favor. Special tax breaks from investing in retirement accounts make them the closest to free money you’ll ever find. You get an instant return with your investment and tax-free growth for decades.
Yes, the stock market is rigged against you. Yes, it sucks. There’s not a lot you can do about it except push for tougher regulations. Don’t let this keep you from making money and reaching your financial goals. Invest for the long-term and in investments outside the stock market.