Sunday, December 1, 2013

Breaking up Cartels: Benefiting Indivdual Investors

The Wall Street Journal gives thanks this Thanksgiving holiday on behalf of the individual investor. The Journal says be grateful for legal and regulatory reforms that broke up the U.S. brokerage cartel and for increased transparency, all of which have operated to make it easier and less expensive for individuals to successfully invest. 

Transparency increased by rule in fits and starts, and was facilitated enormously by the internet which makes most firm, industry and financial data and information click-available in real time and casts light which makes it much more difficult for scammers to hide from the truth. The regulatory sea change that curbed the brokerage cartel started during the Ford administration.
On January 23, 1975, the SEC formally adopted rule 19b-3, ending all fixed commission rates charged to non-member investors, effective on May 1st. SEC Chairman Garrett stated, "For the first time in almost 200 years, the rates of commission that brokers charge to public customers …will not be determined by exchange rules. Market forces will operate to set these prices and there may be variances from firm to firm."
Chuck Schwab, to the ever lasting enmity of brokerage industry brethren at Merrill Lynch, Morgan Stanley, EF Hutton and other old line brokerages, understood opportunity when he saw it. 
Wall Street rumbled, and Charles R. "Chuck" Schwab became one of the first to embrace new trading rules that opened the way to discount brokerage, putting him on a path that would eventually make him a household name. 
The new rules abolished fixed commissions that had kept the cost of trading stock in the stratosphere, giving masses of average American investors a potent whiff of freedom.
Before that, investing opportunities for millions of households long had been constrained by a clubby brokerage industry that indulged large institutions at the expense of individuals. 
The game changed substantially on May 1, 1975, when the brokerage industry deregulated commissions, acting on a Securities and Exchange Commission mandate. For the first time in more than 180 years, trading fees were set by market competition. 
Deregulation paved the way for an entire new industry -- discount brokerage -- in which ordinary investors bought and sold securities without a stockbroker, making their decisions themselves.
The Journal interviewed James Cloonan who founded the nonprofit American Association of Individual Investors in 1978. "There's more opportunity to do well, and less opportunity to be cheated, than there was in the past."
If you are pessimistic about investing, Mr. Cloonan says, you need to recognize how far individual investors have come. When AAII began, you had to spend hours in a public library or write away to a company just to see its financial statements. Brokerage costs and mutual-fund fees were outlandish; tax rates were larcenous. 
Had you bought 100 shares of a stock trading at $20, you would have paid a commission of at least $42 in the late 1970s, according to historical data from Theodore Aronson of AJO, a money-management firm in Philadelphia. Research by Charles Jones, a finance professor at Columbia University, shows that you also would have incurred roughly 25 cents a share in "spread," the difference between what the seller was willing to accept and what you had to pay. 
All told, your trading costs probably exceeded 3%—and would have been much higher on less frequently traded stocks. The same trade today could cost you under $10, or 0.5%, at least 80% less than in 1978. 
In 1978, most mutual funds charged "sales loads," or commissions, up to 8.5%. You often had to pay the same to reinvest your dividends back into the fund. Total return—earning not only the change in market price but also the growth of your reinvested dividends, a concept that investors today take for granted—was almost entirely hypothetical. 
If you did make any money, Uncle Sam took roughly half.
As a leading example of how commissions have plummeted, here is Fidelity's current commissions schedule.
Trading Commissions and
Margin Rates
Whether you trade stocks, options, bonds, or CDs, you'll receive competitive online commission rates—lower than Schwab, TD Ameritrade, and E*Trade.
Online Commissions, Fees, and Concessions
All online U.S. equity trades
Any number of shares or trades
$7.95 per trade
All online options trades$7.95 per trade, plus
$0.75 per contract
Purchase 65 iShares® ETFs onlineFree
Purchase 10 Fidelity sector ETFs onlineFree
All other ETFs$7.95 per trade
U.S. Treasury Auctions, incl. TIPS AuctionsFree
U.S. Treasury Bills, Notes, Bonds, incl. TIPSFree
GSE (Agency Securities), secondary CDs$1.00 per bond
Municipals$1.00 per bond
Corporates (BBB– or higher), CATS/TIGRS$1.00 per bond
Corporates (BB+ or lower)$1.00 per bond
Primary market CDsFree
Secondary market CDs$1.00 per bond
Mutual Funds*
Fidelity and non-Fidelity fundsFree
Most FundsNetwork Transaction Fee funds$49.95 flat fee**

Current day bid/ask spreads (analagous to the difference between wholesale cost and retail price) for most large cap and other high volume trading stocks are fractions of a cent. For mid and many small cap stocks the spread is typically is no more than a penny or two. Although many mutual funds continue to charge a load when sold in less than a prescribed period of time, their sales charges are increasingly irrelevant because with the advent and enormous growth of ETF's (Exchange Traded Funds) you don't even have to buy a mutual fund to buy a mutual fund.
You pay either the $7.95 stock trading commission or nothing at all. Fidelity offers 75 commission free ETF's, including the following.

iShares ETFs by asset class category

Large-Cap S&P 500 Growth Index (IVW
Core S&P Total U.S. Stock Market (ITOT
Core S&P 500 (IVV
S&P 100 Index (OEF
S&P 500 Value Index (IVE
Mid-CapS&P Mid-Cap 400 Growth Index (IJK
Core S&P Mid-Cap ETF(IJH
S&P Mid-Cap 400 Value Index (IJJ
Small-CapS&P Small-Cap 600 Growth (IJT
Core S&P Small-Cap (IJR
Russell Micro-Cap Index (IWC
S&P Small-Cap 600 Value Index (IJS
  • Dow Jones Select Dividend Index (DVY
  • Dow Jones U.S. Real Estate Index (IYR
  • S&P U.S. Preferred Stock Index (PFF
  • MSCI USA Minimum Volatility Index (USMV

A dubious pleasure of living in the great state of Montana is being represented by the self described "dirt farmer" from Havre, one Jon Tester. Tester was re-elected with a plurality of the vote after his allies spent heavily in the final weeks before the 2012 election supporting a large-scale advertising push for the Libertarian Party candidate Dan Cox, attacking Tester's Republican opponent Denny Rehberg. Tester has seniority now; he used that to accede as Chairman of "the powerful Senate Banking Subcommittee on Economic Policy" which has "oversight responsibility for the recently created Financial Stability Oversight Council charged with addressing systemic risk to the financial system." Before he was a full time dirt farmer Tester taught music in the public schools.

Senator Jon Tester's United States Senate Financial
Disclosure Report
covering 2012

From Senator Tester's financial disclosure statement (filing required by law) we can see what his personal experience is with finance and the financial system. 

The man is 57 years old. Tester has no debts. But his sum total financial assets are in the range of $16K to $65K range. He owns somewhere between $1,000 and $15,000 in stocks, that being AEP, a boring, stodgy electric power utility. On Suze Orman's "How am I doing metric" Jon Tester would score a big fat "F". 

But Jon Tester knows what is good for the individual investor. Jon Tester says he wants the SEC to impose a uniform fiduciary duty on brokers.
A rising leader on the Senate Banking Committee today pushed the Securities and Exchange Commission to advance a regulation that would subject brokers to an investment advice standard. 
“I would encourage the commission to make this a priority because I think there is an absolute benefit to investors,” Sen. Jon Tester, D-Mont., told SEC Chairman Elisse Walter at a hearing on implementation of the Dodd-Frank financial reform law. 
Mr. Tester recently was appointed chairman of the Senate Banking Subcommittee on Securities, Insurance and Investment.
Let me translate how a fiduciary duty operates. It requires that your broker know you, study you, analyze you and make decisions for you. And it would mark a return to the high commission, high regulatory and market obstacle regime that's been chipped away over the last three and one half decades.  

Under uniform fiduciary duty, forget about placing an order through the internet, and expect the cost of trades to increase hundreds of percent.  Or alternatively, face a requirement to turn over a percentage of your assets every year to some faceless MBA who knows and understands you about as well as I do. 

Dudes and dudettes, if you want independent investment advice, you can pay for it, usually by turning over a percent or two of your financial assets every year to a financial adviser.  But I, and millions of others don't need or want it. I wrote the junior senator from Montana a missive, where I said, 
That is a horrible idea.  I maintain brokerage accounts with a discount broker.  I don’t need nor want you or a broker to tell me what financial decisions and investments I should or should not make.  I don’t want to pay for useless advice.  And I most vehemently object to sharing my private financial and personal information, which are necessary to consummate a fiduciary relationship, with crooks that populate the financial sector or with any of your conflicted, hand wringing financially illiterate nanny state interlopers, who are looking for ways to carve continuous fees from my hard earned, saved and invested assets. 
Senator Tester distinguished himself in response by doing something that no other House member or Senator had done to me prior. He ignored my communication. No response nine months later, not even a thank you for your thoughts. Senator Tester, why don't you stick to regulating trucks and leave the investing to us?

Senator Jon Tester blowing his own horn.

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