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The System Is Rigged Against The Small Investor

The system is rigged against the small retail investor, and there’s little anyone can do about it. There are too many players getting their palms greased (i.e., Wall Street brokers, market makers, politicians, and even the exchanges) for any hope of real change materializing to help the little guy. In the meantime, the gravy train will keep rolling, and the fat will keep getting fatter.

There is data to back up the reality for retail investors. JP Morgan keeps a rolling tab on the average 20-year returns for retail investors through its Guide to the Markets.

​​According to the latest numbers, the average retail investor has averaged a return of 2.9% over the past 20 years. At current inflation numbers (8.5% reported in March), the average retail investor can expect to lose 5.6% in the market this year.

Why are returns for the average retail investor so dismal? It’s because the system is rigged against them. Jon Stewart exposed this fact in a recent podcast titled How People Cheat The Stock Market | The Problem With Jon Stewart Podcast | Apple TV+ available with a subscription to Apple TV+ or free on YouTube.

In his podcast, Jon Stewart, along with Robert Jackson, Jr., former United States SEC Commissioner, discussed the problem with Wall Street and why it’s rigged against the little guy.

​​Here is the condensed version:

1 – Underenforcement.

​​The SEC is understaffed, and the bad actors, armed with expensive lawyers, often get off scot-free or with only a slap on the wrist. The justice system punishes white-collar crimes differently than violent or drug crimes. If a white-collar criminal does end up serving time in a federal facility, it won’t be anything like notorious state facilities like Rikers Island, Folsom, San Quentin, or ADX. With federal white-collar facilities often referred to as Club Fed, it’s no wonder many Wall Street bad actors who have a penchant for ripping off the little guy have little fear of repercussions.

​​What is a $250,000 fine to a Wall Street firm relative to the tens of millions it’s gaining by cheating in the most common scenario?

2 – Payment-For-Order-Flow.

​When a retail investor puts in a buy or sale order, the expectation is that the broker or exchange executing the order will get the retail investor the best price – the lowest price on a buy order or the highest price for a sale order. Of course, this isn’t how the system works.

The payment-for-order flow is essentially the payment (kickback) to a broker in exchange for directing retail orders to market makers (middlemen who align buyers and sellers), who then front-run these orders to fill them at higher prices. This is how Robinhood makes money. Anybody who thinks Robinhood is letting investors trade for free out of the good of their heart is mistaken.

Robinhood makes money by bundling all the free trades on its platform over to high volume traders (aka market makers) who execute the orders in bulk (high volumes) but at slightly higher or lower prices to pocket the difference-making money from the price spreads from front running. These market makers pay Robinhood for routing the deal flow to them.

This pay-for-order system is rigged against the retail investor, who may lose pennies on a single trade, but when these trades add up to the tune of billions of dollars every year, the losses are significant.

3 – Retail Investors Get Old Information.

The markets are supposedly efficient – meaning everyone has access to all relevant information simultaneously so that no single investor has an information advantage over other investors. That’s the ideal, but it’s not how it works. According to Robert Jackson, Jr., two different information feeds are coming from the stock market.

During the Podcast with Jon Stewart, Jackson pointed out that the “public feed” is run by exchanges like the New York Stock Exchange (NYSE). “Over time, the exchanges became for-profit vehicles,” said Jackson. That’s when the exchanges offered a faster, more improved version of their feeds to private customers at the expense of the public.

​​An example of a private feed is the NYSE Integrated Feed, available to exclusive Wall Street players for a price. At the same time, the public gets staggered information – putting them at a disadvantage once again.

4 – Politicians.

Wall Street is in Washington’s back pocket and vice versa. Wall Street firms spend billions of dollars each year lobbying politicians. According to a CNBC article, “Wall Street executives, their employees, and trade associations invested at least $2.9 billion into political initiatives during the 2020 election cycle.”

​​Wall Street is paying Washington protection money, and politicians have no incentive to cut off the gravy train, so the rest of us can expect little change to this rigged system.

Why Play The Game?

If you know the house is cheating, why play the game? ​​Smart investors don’t. They have no problems turning their backs on a system that has turned its back on them – a system that is underenforced, ruled by market makers, built to bilk the public out of timely market info, and one that politicians will always protect.

Smart investors shun Wall Street for the private markets where there are no ongoing conspiracies to enrich Wall Street at the expense of Main Street. The sooner a retail investor realizes the game is rigged, the sooner they can start making real returns in the private markets.

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