Warren Buffet is one of the most envied people in finance, but as far as he is concerned, you’re the type of investor he wishes he could be.
At a shareholders meeting years ago, Buffett claimed he could generate 50% returns regularly, if only he had less money.
It all comes down to scale. Berkshire Hathaway is so huge that all but the most massive deals are too time intensive to be worthwhile.
Say Buffett bought a company with a market cap of $300 million. Even if it doubled in size, it would only boost Berkshire’s Hathaway’s market cap by a measly 0.08%.
While he is forced to diversify to the point of diluting gains, we could easily make a much larger percentage gain owning just a tiny fraction of the company.
I think Buffett missed something big though, and it could break either way for small investors like us.
While he may not have the same kind of investments available, how he can invest is far better.
We might not get preferential treatment and class A shares, but that doesn’t mean we have to put up with the three major ways we’re being screwed by Wall Street. And how Buffett would like to invest for far greater gains ties directly into how we can put an end to it.
Rigging the Game
There are a whole lot of ways that small investors are getting the raw end of the deal, but we can break them down into three general categories.
Pay to play — Examples of these underhanded deals abound, especially after Michael Lewis published Flash Boys and made high-frequency trading easier to grasp.
But one of the biggest risks comes from one of the fastest growing sources of small investor shares.
Dark pools, set up outside of public exchanges, now account for about a fifth of all share transactions. Brokerages sign up to trade amongst themselves, and the lack of transparency has created new underhanded ways to profit.
The SEC itself has discovered a slew of questionable, or downright illegal, activity in dark pools.
Most commonly, it is false advertising. Brokerages will claim that they don’t allow proprietary trading, all while running their own secret trading desks to take advantage of the trades they process for others.
And, just last year, the SEC brought an enforcement action against one operator of a large dark pool because, among other things, it secretly offered high-speed traders special order types that gave them an unfair advantage over other subscribers.
The operator even knew how to double dip, playing both sides of the fence. In addition to giving high-frequency traders an unfair edge, this operator secretly allowed some of its favored subscribers to avoid trading with those very same high-frequency traders.
Selling themselves — The second broad way Wall St. hurts small investors is through proprietary, or house-brand, mutual funds.
These funds are often packaged into employer-based retirement funds, such as 401(k)s, and have a wide range of conflicts-of-interest.
Right off the bat, there is often no fiduciary obligation, or there is at least enough ambiguity that there is no possibility of prosecution.
This leads to abnormally high fees, some as high as 2% per year, that greatly reduce gains for small investors over time.
Then there are the perverse bonus systems built around these in-house products. Brokers and managers make extra money by pushing often inferior funds and ETFs onto small investors if they are offered by their employer.
Then there are the actual stocks they hold. A brokerage or fund provider that has preferential services for high-net-worth clients, or its own trading desk, can use these baskets to soak up underperforming assets.
The big players keep the good stuff, the rest gets lumped into the pool for the small investors.
Limiting access — Finally, there are efforts to arbitrarily and severely limit the types of investments people can make.
This practice isn’t limited to riskier types of trades, like futures, options, and other derivatives. They often apply to the same kind of shares you can buy and sell through public exchanges.
This may mean limiting your trading account to certain exchanges and dark pools, or setting an artificial limit on the share price of a stock. Or it means charging punitive trading fees and long delays to fill orders.
The ultimate goal is to limit how you trade to how they want you to trade. If you only trade equities that Wall St. itself trades, then it can always act as a middleman and make a profit.
How to Stop It
The last example plays exactly into how to avoid being abused by Wall St., and the type of investments Warren Buffett wishes he could make.
And it all ties into how, as technology investment analyst Louis Basenese says, “High-flying hedge fund managers are, well, too rich to own them. With billions in capital to throw around, they can’t buy and sell such investments without radically influencing market prices.”
Set up your own online brokerage account, and you can invest in ways Buffett, fund managers, and Wall St. traders, simply cannot — companies with incredible business models and growth that simply aren’t large enough yet to handle massive billion-dollar investments.
All it takes is to look beyond the investments Wall St. is paying billions to market to you, and start researching the smaller corners of the stock market that it can’t enter.
