Before World War I, participation by ordinary individuals in the securities markets was close to nonexistent. When J. P. Morgan & Company and the other major banks of the turn of the century raised capital through stock and bond issues, they turned to institutional investors such as insurance companies, trust companies, and a small core of very wealthy families that were, in effect, institutions. The great majority of secondary trading in those issues on the stock exchanges was between the same institutional investors or, more often, between the traders doing business on the exchange floors. There was no “retail” market for stocks and bonds of any note.
That would begin to change, however, with the sale of Liberty Bonds to a wide swath of Americans as part of the financing of World War I. Liberty Bonds were the initial capital market investment for the great majority of their buyers, and just when the government began paying off its debt at war’s end, the country was entering the prosperity of the 1920s. The new industries and fast-growing companies emerging during that time provided an enticement for some investors to recycle the proceeds of Liberty Bond repayments into the stocks and bonds of new enterprises. But the experience of many, perhaps most, of those investors did not end well. If they did not become the victims of pool operators or the shoddy investment merchandise manufactured by the likes of Sunshine Charlie Mitchell at National City Bank, their investments lost much of their value following the stock market crash of 1929.
The good news about the plight of the early retail investors, however, is that there weren’t many of them. There was a great deal of public interest in the ever-ascending stock market during the Roaring Twenties, but for the overwhelming majority of Americans the market was just something watched from afar. Unlike today, when over half of U.S. adults have a direct personal stake in the stock market, in 1929, at the height of the speculative frenzy, little more than 1 percent of the U.S. population was “playing the market.” For the great majority of Liberty Bond holders, their patriotism did not extend to a reinvestment in American enterprise.
And it stayed that way for some time. The Great Depression and the austerity of World War II washed out any significant interest by Main Street in Wall Street—and vice versa. But the postwar prosperity and the expansion of a middle class with discretionary income led to a reawakening of interest in the securities markets from a new and much larger contingent of retail investors. Much of that renewed interest arose from the growing and more widely spread affluence in the mid-twentieth century, but some of it surely came from the investors’ sense that they now had a better than fighting chance to do reasonably well by virtue of the New Deal securities legislation and the greater transparency and fair practice it promoted. With the creation of the Securities and Exchange Commission and the tough legal requirements for full disclosure in the sale of stocks and bonds, President Franklin Roosevelt could proclaim with some justification that the markets were now characterized by both caveat emptor and caveat vendor.
There is unlikely to ever be a truly level playing field for the Wall Street professional and the retail investor, but the investment firms that prosper long term when dealing with individuals are those that proclaim and actually practice fair dealing with their customers. And the firm that pioneered the customer-friendly model first and most successfully was the post–World War II version of Merrill Lynch. Chapter 5 describes how that firm, founded and led by the visionary Charles Merrill, adopted unheard of practices to gain the confidence of investors. Research reports were prepared for Merrill Lynch’s customers, who were encouraged to “investigate, then invest” rather than speculate based on market tips, and its brokers—now called “account executives”—were salaried, usually college graduates, and all products of Merrill Lynch’s comprehensive training program.
Merrill Lynch would later stray far from its core mission of serving the retail customer, but the firm and its many imitators were a significant reason for the surge in participation by small investors in the stock market. By 1970, at the end of the Soaring Sixties, over three-quarters of the trading volume on the New York Stock Exchange was accounted for by the retail segment of investors, and the number of U.S. households owning stock increased more than tenfold from that of the Roaring Twenties. This unprecedented movement to everyman capitalism was accompanied by a cultural shift in the American public’s view of business and finance, and when Time magazine compiled its list of the one hundred most influential individuals of the twentieth century, Charles Merrill was included and properly credited for creating a “shareholder nation.”
Despite his insistence on providing small investors a fair shake in the market, Merrill had a blind spot regarding mutual funds. He remained adamant throughout his lifetime that retail investors were better off assembling their own portfolios of securities under the guidance of his firm’s account executives, and throughout his tenure as chairman of the board of Merrill Lynch between 1940 and 1956, he forbade the sale of mutual funds. That policy remained in force for many succeeding years, but a growing number of investors began opting for mutual funds as a safer and more sensible way to participate in the securities markets. The migration of small investors to mutual funds was especially notable during the tough investment environment of the 1970s and early 1980s, when those investors with battered securities portfolios increasingly ceded the job of investing to mutual fund professionals.
That common sense shift in investment strategy to mutual funds—few individuals have the time or inclination to construct a do-it-yourself stock portfolio—was bolstered by another major change: the abandonment by many corporations of “defined benefit” pension plans for their employees. Those corporations, as sponsors of such plans, used to guarantee pension payments upon employee retirement and took responsibility for funding and managing the plans’ investments. Today, however, most company employees are on their own when it comes to retirement planning and fend for themselves through “defined contribution” plans, mainly the now-familiar 401(k) plans. Most individuals typically (and rationally) use common stock–based mutual funds—or the close substitute, exchange-traded funds—as the investment of choice for the equity portion of their 401(k) plans. As a result of the shift to defined contribution retirement plans, more than 50 percent of today’s American households have a direct interest in the stock market, and that interest is mainly in the form of mutual funds and exchange-traded funds.
Mutual funds or ETFs are the right choice for most individuals for the diversification and professional management they provide. Furthermore, investing in the stock market, nerve-racking though it may be, is still considered the best way to fund a decent retirement or to realize other long-term financial goals. But from their inception, there had been a major drawback to mutual funds, namely the exceedingly high fees mutual fund companies routinely charged their investors. The combination of high commissions to purchase or sell a fund—the so-called front-end and back-end loads—along with stiff management fees, cut deeply into the investment returns the mutual funds’ owners ultimately realized, making it more difficult to accumulate a sufficient nest egg over time.
Chapter 6 describes how John Bogle came to the rescue of the mutual fund investor. Based on the assertion in his senior thesis at Princeton University in 1951 that mutual fund managers provide no better performance than the overall results of the stock market—and buttressed by later academic studies and his own experience as a mutual fund executive that confirmed his assertion—Bogle launched the world’s first index mutual fund for retail investors. At first derided as “Bogle’s folly,” his low-cost, indexed mutual funds—very low cost since minimal management is required—simply mimic the results of the Standard & Poor’s 500 Index and other well-known market indexes. As a result, the users of those funds, whether for a 401(k) plan retirement or otherwise, have an economical means to capture the well-established benefits of equity investing. Due to “Saint Jack’s” creation, investors on Main Street are very close to being on the same plane with Wall Street.