When Wall Street Cheats, Do We Lose?

Billionaire investor Raj Rajaratnam was convicted of insider trading. Prosecutors had alleged he made profits and avoided losses totaling more than $60 million from illegal tips. i i

Billionaire investor Raj Rajaratnam was convicted of insider trading. Prosecutors had alleged he made profits and avoided losses totaling more than $60 million from illegal tips. Louis Lanzano/AP hide caption

itoggle caption Louis Lanzano/AP
Billionaire investor Raj Rajaratnam was convicted of insider trading. Prosecutors had alleged he made profits and avoided losses totaling more than $60 million from illegal tips.

Billionaire investor Raj Rajaratnam was convicted of insider trading. Prosecutors had alleged he made profits and avoided losses totaling more than $60 million from illegal tips.

Louis Lanzano/AP

When you read stories of insider trading — resulting in multimillion-dollar profits — by crafty people like hedge fund manager Raj Rajaratnam or arbitrageur Ivan Boesky, it seems like the average investor is at a constant and insurmountable disadvantage.

After all, these are the guys who got caught. What about all the slicksters who don't get nabbed? And all the big dog investors who don't have day jobs and watch the stock tickers like vultures? And what about the automated algorithm-driven trading programs designed to squeeze an advantage out of trades-by-the-nanosecond?

Up against all that, how does the small-time market player stand a tinker's chance? It all seems so unfair. Why should an individual investor even put money in the stock market anymore? It's crazy. It's insane. It's ... gasp ... it's ...

Taking Control Of Your Future

Bill Schultheis, a former broker at Smith Barney and author of The Coffeehouse Investor, calmly advises against such hyperventilation. He feels the loneliness of the long-distance shareholder who just wants to grow his 401(k) and retire with enough money to live on and to buy the occasional Bordeaux.

While Rajaratnam sits in home detention awaiting sentencing, Schultheis says, there is another type of investor who has never even heard of Rajaratnam. The quietly savvy ones, he says, "are doing all they can to build wealth for retirement, ignore Wall Street and get on with their lives."

Schultheis still believes that the individual investor can, and should, take control of his financial decisions and destiny. As investment guidelines, he suggests three everything-I-know-I-learned-in-kindergarten simple rules:

1. Save for a rainy day. Establishing a personal financial plan is essential to building long-term wealth.

2. Don't put all your eggs in one basket. Determine how to best allocate investments among stocks, bonds and other asset classes in a way that is appropriate for you in relation to where you are in your life.

3. There is no such thing as a free lunch. The smartest way to maximize your return potential in a globally diversified portfolio of stocks and bonds is through a lineup of low-cost index funds.

'Lazy Portfolios' And Other Advice

The Coffeehouse Investor method — which suggests putting 40 percent of your investment in an intermediate bond index and 10 percent in each of a half-dozen recommended stock funds — is included in the MarketWatch list of "Lazy Portfolios" that should earn money without too much vigilance.

MarketWatch also showcases other Lazy Portfolios, such as Margaritaville and Dr. Bernstein's No Brainer.

Still, individual investors can be hurt by trading fraud and manipulation, says Eleanor Blayney, consumer advocate for the Certified Financial Planner Board of Standards. And she says that is an important reason for vigilant government regulation of financial markets and service providers. "But this does not mean that the small investor should avoid investing in the stock or capital markets, or is destined 'to lose' to the big players," Blayney says.

She offers investors the following broad-stroke recommendations for participating in the markets:

* Focus on well-run, low-cost mutual funds where your money is part of a large investment pool. "The benchmark for low costs would be Vanguard mutual funds," Blayney says. "So I would advise comparing any mutual fund to the nearest counterpart at Vanguard. It's important to do an apples-to-apples comparison: index funds to index funds ... managed large-cap stock funds to other large-cap stock funds. Generally speaking, international funds and small-cap funds are going to have more expense-management fees than domestic large-cap funds. Index funds are going to be less expensive than managed funds."

* Focus on index investing, where your returns reflect broad market movements, and not the performance or choices of a single individual or manager.

* Avoid any investment strategy that is not transparent or that you do not understand. Hedge funds are often "black boxes" to the average investor and therefore not appropriate.

Not surprisingly, she also suggests working with a professional certified by her board, someone who manages assets for clients and is an investment adviser, to develop an investment plan. "They are required to adhere to a fiduciary standard," she says. Often these advisers are also considered institutional investors and therefore get favorable pricing from custodians and mutual funds that can be passed on to individual clients.

The volatility of this era, Schultheis says, "will challenge us like never before to tune out the financial pundits of today and tune in to our own lives and dreams and careers."

By making the right decisions, he says, the personal investor can "experience a richness of life that transcends Wall Street's million-dollar bonus babies."

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