Effect of Volatility on Three Portfolios ($10,000 starting value)

Year 1

Year 2

Year 3





Portfolio #1                            Portfolio #2                            Portfolio #3

10%        $11,000.00

10%        $12,100.00

10%        $13,310.00



15%        $11,500.00

25%        $14,375.00

-10%       $12,937.50



60%        $16,000.00

-50%       $8,000.00

20%        $9,600.00




Add It Up 

There are several reasons that the greatest consumer fraud in history (the system in which Americans invest) flourishes. Among them is the complicity of the Senators and Representatives entrusted by the public to oversee the regulation of this system. These lawmakers routinely receive campaign contributions (i.e. bribes) from lobbyists representing the very same companies they are ostensibly regulating. And when they leave the Senate and House to return to private life, a shocking number of them become highly paid lobbyists for the financial services industry.* Consequently the people’s representatives zealously protect the industry’s interests, instead of the public’s. For an ugly example of this zeal, note the overt hostility that Elizabeth Warren encountered during her 2011 appearances before the House Financial Services Committee to answer questions related to the agency whose creation she directed, the Consumer Financial Protection Bureau.

First and by very far foremost, the greatest benefit that the investment industry receives for its lobbyist conveyed campaign contributions, and the revolving door it operates, connecting ex- Senators and Representatives to their next job as Wall Street lobbyists, is the outrageous rule that allows mutual fund companies and brokerage firms to collect their fees without having to send out a monthly bill. Instead, they simply access their customers’ accounts and deduct the fees, and because the disclosure requirements of these deductions are pathetically weak, millions of Americans never realize that among their largest monthly expenses is the cost of their investment funds.

Consider: two 40 year old couples, both with $100,000. Couple A (representing most Americans) invests in actively managed mutual funds, paying 2.8% per year in fees. Couple B invests in index funds and ETFs, paying 0.2% per year. 25 years pass with both couples’ portfolios earning 7% per year. Couple A will be left with $266,840. Couple B will be left with $516,247. Add it up:

To discover how much of your money is being invisibly seized by mutual funds, register on this website which provides three free examples of its mutual fund cost analysis. Crucially, this cost analysis includes trading costs, which despite being paid by all mutual fund shareholders, are somehow not required to be included in a fund’s “expense ratio” (a fund’s expense ratio is supposed to reflect the annual cost of owning a fund). These trading costs are disclosed only if a shareholder contacts their fund company to request a “Statement of Additional Information.”

It’s not just the 99% that are victimized by this billing subterfuge. If you are a client of a white-shoe brokerage firm, you likely own a proprietary fund, and if it is a “Fund-of-Funds” (typically composed of several different, private, money management firms), then God help you. These proprietary funds are the apex predators of investment swindles. Own one? Then this scenario may sound familiar: A stockbroker / financial consultant / investment advisor calls a client and recommends that they allocate 10% of their portfolio to a proprietary Fund-Of-Funds, which invests in an exotic asset class, such as Private Equity, Real Estate, or Commodities. For this example we’ll use Commodities. The broker explains that as an asset class commodities have an excellent record of strong historical returns with a relatively low correlation to stocks, providing excellent diversification, and should have a place in every portfolio (all true). A prospectus is delivered to the client. Because the Fund is actually six separate funds blended together, the prospectus is 500 pages long. 500 virtually incomprehensible pages of esoteric financial terms and legalese. It is discarded; either immediately or after the client has slogged through a few torturous pages. Consequently the page that details the fund’s expenses is never read, and the client never discovers that this Fund-Of-Funds has annual fees that amount to 8%. If by some miracle the client eventually learns that the fund costs 8% per year and seeks recompense through an arbitration hearing, he will find out that despite never having mentioned the unheard of annual cost of the fund, the stockbroker has violated no rule, because the annual fee was disclosed inside the prospectus, on page 397. This scenario is not uncommon, and may help explain what President Obama stated regarding the lack of any prosecution of high level Wall Street executives for their role in the mortgage-backed bonds fiasco. Yes, he stated, their behavior was outrageous. The problem was that according to the rules that existed, it wasn’t illegal.

“Compound interest is the eighth wonder of the world.”

Although Albert Einstein may never have spoken those words, the quote has often been attributed to him. Either way, the message: that the combination of time and consistent, relatively modest, annual returns, will dramatically multiply any investor’s bottom line- is sound. Unfortunately its wisdom is typically lost on American investors. The reason for that is simple: They have been bamboozled by two entities; the financial media that informs them, and the financial services firms that advise them, both of which would experience crippling profit reductions were the American public to recognize their guile and learn that they would be far better off in index funds, and also by seeking slower and steadier returns instead of trying to achieve 25% every year. Walk into a bookstore and peruse the covers of the business magazines. The years change but the covers don’t, always looking something like this:

The Top 5 Mutual Funds For 2012

The Ten Stocks Every Investor Should Own In 2012

The Next Great Mutual Fund Manager

The cable business channels also use chicanery to peddle this nonsense, by constantly interviewing portfolio managers and stock analysts. All of it encourages investors to foolishly attempt to achieve high annual returns. If Americans learned the truth: that it’s virtually impossible to outperform the market indexes for very long, there would be no need to buy one of these magazines, nor to tune in to a business channel to listen to their ‘experts’. Most importantly, they would remove the layer of leeches (actively managed mutual fund companies and any stock broker promising high annual returns) that has inserted itself between American investors and the markets (stock, bond, commodity) in which they seek to invest. This would be accomplished by placing all of their assets in Index Funds and Exchange Traded Funds, which simply track the market indexes and cost very, very little. It would require pressuring employers to include index funds and ETFs in company sponsored retirement plans. These retirement plans are typically populated with just the opposite: only the most expensive, actively managed mutual funds. This is because the mutual fund companies that provide these retirement plans regularly offer to waive the annual cost that companies are charged for maintaining one, in exchange for being allowed to select the funds that are offered to a company’s employees.

Investing, despite the mystical shroud that envelops it, is simple to understand. There are roughly 5000 companies whose stock publicly trades on exchanges in the United States. There are benchmarks, or indexes, used to report the annual returns of these stocks. While there have been extended periods of either very strong returns or very damaging losses, the historical, average return of the overall stock market is about 8 or 9%. When investors seek to grow their money by exposing it to this market, they have two choices:

Option A:  Pay investment professionals. These are usually portfolio managers at mutual funds, whose job is to choose about 100 stocks out of the 5000, endeavoring to achieve a higher annual return than the indexes. Additionally, stockbrokers or financial planners are often hired and depended on to select the investor’s mutual funds, adding another layer of fees.

Option B:  Entirely remove the human element from the equation, by investing in index funds, or their closely related cousins, Exchange Traded Funds (which are just index funds that trade on stock exchanges). With index funds and ETFs, there is no portfolio manager. Whatever the index returns for a particular year, the investor does too.

•In 2009 alone over 1400 former members of Congress, Capitol Hill staffers, or federal employees registered as lobbyists on behalf of the financial services sector, including 73 former lawmakers and 40 former Treasury Department employees; (Washington Post, Analysis by Center for Responsive Politics and Public Citizen). This leads to a question: Is there anybody that leaves a government job in Washington that does not become a lobbyist for the financial services industry?

That Senators and Representatives, continue, without compunction, to blatantly and consistently place the interests of financial services companies above those of their constituents is infuriating. That they do so without fear of the wrath of their constituents, indeed with every confidence of being reelected, is a phenomenon. Why do voters support politicians that act contrary to their interests? It’s nothing new. Twenty years after the Civil War ended, U.S. Grant fulminated over this very question.   

“Mr. Jefferson Davis said in a speech, delivered at La Grange, Mississippi, before the secession of that State, that he would agree to drink all the blood spilled south of Mason and Dixon’s line if there should be a war. The young men who would have the fighting to do in case of war, believed all these statements, both in regard to the aggressiveness of the North and its cowardice. They, too, cried out for a separation from such people. The great bulk of the legal voters of the South were men who owned no slaves; their homes were generally in the hills and poor country; their facilities for educating their children, even up to the point of reading and writing, were very limited; their interest in the contest was very meager—what there was, if they had been capable of seeing it, was with the North; they too needed emancipation. Under the old régime they were looked down upon by those who controlled all the affairs in the interest of slave-owners, as poor white trash who were allowed the ballot so long as they cast it according to direction.”

-Ulysses S. Grant

Personal Memoirs