Why I Hate the Stock Market
Clickbait alert – I don’t actually HATE the stock market.
But here is why I struggle with investing in the stock market versus real estate, especially for John or Jane Q Public.
The Stock Market Has a Place in Any Portfolio
At the risk of sounding manic, I do believe there is a place for the stock market in anyone’s portfolio: the 401K. Almost all 401Ks are focused on traditional stock and bond portfolio investing. You usually can’t invest in individual stocks or non-traditional investments, but you can invest in a series of funds that help you diversify your 401K across risk, asset, countries, time to retirement, etc. The money you invest in a 401K goes directly from your paycheck to the 401K without being taxed, and most employers include some type of matching.
Most financial advisers (which I am not) will tell you to at least capture your employer’s match. I don’t inherently disagree, but I do believe that if the only investing you are doing is pre-tax into the 401K, you should rethink your investing strategy.
The Downside to the 401K
I was laid off about 5 months ago (check out my Lessons from a Layoff posts). The money in my 401K was inaccessible unless I wanted to pay the taxes and penalties. The barrier to accessing 401K funds is not a bad thing. It keeps us from cashing out to buy a new car or pay for next months’ vacation. This keeps us focused on saving and investing for retirement. But what happens when your world falls apart? Or, what if you don’t need to wait until you reach that certain age to retire? What if you want to retire early? Accessing the 401K early becomes tricky.
Retail Investing is a Sucker’s Bet
Investing in the stock market for most of us is a sucker’s game.
Reason 1 – retail investors have a special name among investment professionals. It is called ‘dumb’ money. That’s because most of us don’t and can’t commit to the rigor that goes into investing that the professionals do. This involves understanding the key metrics for an industry, weighing these metrics across companies, determining reasonable entry points to purchase those companies, and then staying committed when prices drop. Which they do. The stock market takes a 10% hit roughly every 10 months, and there are bigger drops less frequently. Electronic trading makes it all too easy to panic and jump out when things go sideways.
The result is a large group of investors that tend to jump on the popular stocks without digging deep enough who then panic at the first sign of a crash. I know, I was one of them, and I talk to them every week. We buy high and sell low, or buy low on the downturn and sell a rock bottom.
Let’s take Tesla stock as an example of what damage retail investors can do to themselves. The market cap for Tesla right now is $834 BILLION dollars. Compare this to Ford, General Motors, Honda, and Toyota. Their combined value is $397 billion dollars. Don’t get me wrong, I am deeply impressed with Tesla. My issue is the stock price right now. It is double that of the four biggest automakers combined. As of December 2019, its market share in the US (the biggest car market in the world) was less than 2%. Toyota’s market share is roughly 15% in the world.
I’m not saying that Tesla isn’t going to catch and surpass its competitors. I am saying that if you assume Toyota’s stock price is representative of its market share, Tesla’s stock price would indicate that it makes up 50% of all auto sales worldwide! But Tesla remains a favorite for retail investors. Dumb money indeed.
Reason 2 – the institutional guys can’t win at their own game. The average mutual fund that is actively managed consistently fails to beat the stock market on average. Investing in an actively managed fund is less successful than investing in an index fund that simply buys proportionate shares of all 500 stocks in the S&P 500. I find this to be an extremely inefficient way to make money because many of the stocks each year fail to perform at all. This is the same for ETFs where you buy into an industry so that you can catch a win on a handful of top performers.
Reason 3 – its too easy to get in and out of the market. You can argue that this is a good thing, but I personally have jumped in and out of stocks way too quickly when the market or the stock went into decline.
Reason 4 – you not only have to be right, but people must agree with you. It is not enough to spend hours researching companies to find one that is a solid investment. You must wait for other investors to agree with your wisdom and drive the price up.
I don’t have a desire to play a game where I am (aptly) named the ‘dumb’ money, a game that most professionals rarely win, and a game where I not only have to get it right, but I’ve got to get the timing correct as well.
Depending on your income bracket, you can probably expect to pay 15% to 20% in capital gains tax.
The long-term historical average annual gain in the stock market has been 8%. This number is somewhat misleading because there are other factors at play, but we’ll run with 8%. If I invested $100,000 in the market for five years making an 8% compounding return, my profit at the end of five years would be around $36,000. Applying the 20% capital gains tax to this, I would lose over $7,000 to taxes.
I went and checked my tax returns on several syndicated real estate investments that I have made over the past five years. My tax burden has been significantly lower. Sometimes as low as 5%, but never over 10%. With real estate, you receive the benefits of the depreciation of the asset which is something you don’t get with stocks. This dramatically boosts the returns from real estate vs. the stock market.
Efficiency and Alignment
Having worked for a couple of publicly traded companies, I can personally testify that the employees and leadership of publicly traded companies generally do not operate in ways that prioritize the interests of the shareholder. The level of inefficiency and bureaucracy at most companies is staggering.
On top of this, executive leadership is compensated for performance that may not align with shareholder interests, even when the board of directors tries to drive that alignment. How many headlines have you read where the CEO of a company continues to be paid exorbitant amounts even as the shares slump quarter over quarter over quarter. Or, a CEO comes in and cuts costs by cutting staff and expenses, gains a bonus, and then everyone wonders why the company underperforms a year later. Surely it isn’t because R&D was cut and the business was understaffed…
Real estate that you own and control works for you. If you are looking for appreciation over time, you can invest accordingly. If you are looking for cash flow, you can invest accordingly. Change your mind five years down the road? Adjust accordingly. You are in control, and you can make your investment work to satisfy your needs and wants. Case in point: my first rental property. We lived in the house for a year before renting it out. During the first three years of ownership, we prioritized cash flow to pay for my Masters. Once we got through the three years, we focused on appreciating the asset. There was deferred maintenance that we took care of, we updated the flooring, and we upgraded the appliances. We then completed a cash-out refinance to purchase an additional property. The same investment provided for evolving financial needs because we controlled it.
Syndicated real estate investments are great because they are passive which allows you to focus on your day job instead of finding, obtaining, and running investments. These investments are finite, and alignment exists between investor and operator.
I personally like that syndicated investments are finite. An operator finds an investment, raises capital for that investment, purchases the investment, and then implements their strategy for that investment. Their focus for that investment is delivering on their investment thesis.
Alignment is the most attractive component to syndicated investments. Most operators do take fees for the acquisition, management, and liquidation of the asset. This helps recoup costs and keeps the lights on and keeps them engaged with the investment, but the real money doesn’t get made by the operator until the investor gets their preferred return. A preferred return (generally between 7% and 9%) is a return that the investor must receive before the profits can be split between operator and investor. Even if the preferred return can’t be paid starting on day 1 of an investment, it accrues and must be paid out before the operator can take any profit.
This return ensures that an operator is motivated to get an asset to perform and begin generating a profit. Because investors come first, it becomes difficult for an operator to profit legally without first ensuring the investor gets a base level return.