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Well, certainly for investors here in paradise, both excitement and uncertainty rule the day. As we ease into the peak of hurricane season, there is also some anxiety as to our current stock market march to the sky. As there are no absolutes as to how and when market turmoil will occur, now may be a god time for some “investing 101” as to what really goes on behind the scenes.
Of course, the Wall Street spin machine has done a wonderful job of both keeping investors in the dark as to what actually goes on behind the scenes, but at the same time they have created a mentality whereby investors live with a sense of “What’s in it for me?” Certainly there should be sound rationale as to how and why certain investing strategies are suitable for any given objective. We should know what we own and why we own it.
However, there are so many nuances that go completely unmentioned during the process of implementing various strategies that at some point even the most uninvolved investors may find these of interest. By now, we can easily establish Americas renewed love affair with the stock market, and rightfully so. The unprecedented bull market run fueled by more hype than substance has created a new mindset for many. However, the realities of stock ownership are completely lost on most.
Many chose individual stock ownership as a portfolio holding. There are various transaction methods available to investors including fee only portfolio management as well as commission driven transactions. Although both have a place in the realm of stock ownership, the realities of profitability are often lost on most. Let’s take a look at an individual stock transaction. Regardless of whether the transaction is through a brokerage or an online service, often there can be lost revenues for the investors that go completely under the radar. Now this is not to suggest that any wrongdoing has occurred, rather, the system simply allows for additional revenue in the form of order execution.
A stock purchase for 1,000 shares of ABC Company may be executed at a price of, say $25 per share. However, often the stock may have been purchased at a slightly lower price than was executed. Perhaps the stock was available for purchase at $24.75 per share. The broker can make the purchase for $25 per share and keep the .25 loss to the customer. Based on 1,000 shares purchased, there is lost revenue for the investor of $250. This is simply how the game works. After all, does anyone really think that the
“1-800-self–serve” firms can pay the bills with a $3.94 transaction; well? Of course not is the answer unless they are a not for profit organization. Behind the scenes indeed.
Another “behind the scenes” misconception is risk versus safety. Many chose to invest with options. These accounts require massive disclosures and disclaimers as to the risks involved with option trading. Certainly there can be significant risk along the way. However, at the same time there are transactions that can be virtually risk-free. For instance, a transaction called “Selling Cover Calls” is an example. Let’s say an investor owns ABC stock with a cost basis of $25 per share. This investor decides that a profit of 20 percent will suffice. He sells an option contract offering his shares for sale, or to be called away from him, at $30 per share.
The investor can profit 2 ways; first, he will receive what is called a premium from the person buying the contract. Second, when the trade is executed at $30 per share, the investor realizes the 20 percent profit on the stock sale price. Again…behind the scenes.
Another “behind the scenes” myth is the misconception of muted returns from an insured index strategy. This strategy allows investors to capture only a percentage of the stock market gains while avoiding any and all stock market losses. The reality is that avoiding losses while capturing even half of the markets returns can outpace the market as a whole long term, which certainly leads to the life of a SWAN, Sleep Well At Night.
William F. Hague is a managing partner of Hague Wealth Management; 239-389-1999 or WFHague@earthlink.net. The opinions and observations stated above are those of the columnist.