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How to Avoid Being a Wall Street Muppet

Posted By Barry Ritholtz On August 31, 2013 @ 9:30 am In Apprenticed Investor,Financial Press,Investing | Comments Disabled

How to Avoid Being a Wall Street Muppet
Barry Ritholtz
Washington Post, August 23 2013

 

 

 

On March 14, 2012, Greg Smith resigned from Goldman Sachs in an op-ed published by the New York Times [1].

It was a notable moment in financial history for a couple reasons. First, Smith leveled an embarrassing public resignation at a storied American investment firm. People don’t just up and quit Goldman that way. (Though the firm has drawn its share of wrath, most famously in a Rolling Stone article [2] by Matt Taibbi that described it as “a great vampire squid wrapped around the face of humanity.”)

Perhaps more notorious was the introduction of the word “muppets” into the lingua franca of finance. After 12 years of lucrative employment, Smith’s conscience had begun bothering him. Goldman’s clients were being “ripped off” and not only that, they were referred to as “muppets” by other employees. Who doesn’t love the Muppets — Kermit the Frog, Miss Piggy and company — those adorably absurdist stars of screen and stage. Goldman did eventually investigate, but it found no evidence of muppeteering.

Amongst the financial Twitterati, the term muppets has come to describe any client used and abused by some financial predator. I’ve adopted the term to describe portfolios that have been assembled for purposes other than serving the clients’ best interests.

I want to draw a distinction between those portfolios that are merely mediocre and a true muppet portfolio. Asset managers have different approaches, and I don’t wish to suggest there is only one way to run money. There are many ways one can attempt to reduce risk, improve performance, lower drawdowns and reduce volatility.

Rather, I want to distinguish between portfolios that try to do right by clients but miss the mark vs. the ones that were assembled for the sole purpose of maximizing commissions to the retail broker, period.

My colleague Josh Brown’s book, “Backstage Wall Street [3],” detailed the myriad ways financial sharks take advantage of unsuspecting clients. These practices supposedly no longer exist. In fact, all too many portfolios are assembled in those sausage factories.

About 10 percent of the new accounts that we see are muppet portfolios. These typically hold hundreds of positions. Mind you, these are not from a family office with $150 million, but a portfolio 1 percent of that size. There is no rational reason for these sorts of assemblages to be holding 100-plus positions.

How does this happen? As Brown explained, brokers are constantly barraged by the Street’s financial wholesalers. These are the mutual fund families, the exchange-traded funds merchants, the product providers who spend their days making presentations to financial retailers.

The broker goes to some conference room or hotel, where over a free lunch of rubber chicken the product du jour is pitched. The explanation of why the product even exists is made, a hypothetical historical performance flashes by, a clip of the manager on TV is played. Afterward, the brokers return to their offices, where they start “smiling and dialing.” Every client gets the smooth sales pitch, filled with those sexy details the broker only learned existed an hour earlier. Repeat every month, and after a few years you end up with muppet portfolios.

A better way to view the investing world, in my opinion, is to break it down to 15 broad asset classes and own all of them. These include stocks, bonds, real estate, commodities and cash. U.S stocks differ from emerging markets, which are not the same as Treasurys or foreign high-yield bonds, to name a few. You want to own all of these because from year to year, no one ever knows which asset class is going to perform the best. And no one can tell in advance which asset class is going to have a bad year. So you own them all, and you don’t worry about it. Much of what you own is going to be going up most of the time.

The beauty of diversification is it’s about as close as you can get to a free lunch in investing. The best part about modern investing is you can access these broad asset classes at very low costs — typically 15 to 50 basis points. And the cost of buying these now through an online broker is less than $10.

Today, a smorgasbord of ETFs offer investors direct access to these asset classes. Exotic instruments add little, if any, value to a properly diversified portfolio.

Don’t be a muppet. “Returnless risk” is not how you prepare for a decent retirement.

~~~

Ritholtz is chief executive of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation [4]” and runs a finance blog, the Big Picture. [5] Follow him on Twitter: @Ritholtz [6].


Article printed from The Big Picture: http://www.ritholtz.com/blog

URL to article: http://www.ritholtz.com/blog/2013/08/how-to-avoid-being-a-wall-street-muppet/

URLs in this post:

[1] op-ed published by the New York Times: http://www.nytimes.com/2012/03/14/opinion/why-i-am-leaving-goldman-sachs.html?pagewanted=all&_r=1&

[2] Rolling Stone article: http://www.rollingstone.com/politics/news/the-great-american-bubble-machine-20100405

[3] Backstage Wall Street: http://www.amazon.com/exec/obidos/ASIN/007178232X/thebigpictu09-20

[4] Bailout Nation: http://www.amazon.com/gp/product/0470596325?ie=UTF8&tag=washingtonpost-20&linkCode=xm2&camp=1789&creativeASIN=0470596325

[5] the Big Picture.: http://www.ritholtz.com/blog/

[6] @Ritholtz: https://twitter.com/ritholtz

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