Wall Street has always been about getting a “one-up” on you and me. The investment classic titled Where Are the Customer’s Yachts? sheds light on the rampant abuses on Wall Street more than one-hundred years ago.
Bestselling author Michael Lewis says, “What [author] Schwed has done is capture fully—in deceptively clean language—the lunacy at the heart of the investment business.”
Unfortunately, financial fraud still exists today. In Flash Boys: A Wall Street Revolt, Lewis points out that we’re now experiencing latest incarnation of the game.
Lewis astutely points out that one way of getting a “one-up” is to skim a penny or so off every share traded. This is how high frequency trading works. Speed enables high frequency traders to get in and get out by jumping to the head of the line. What makes this practice even more damnable is that they can get there by paying retail firms to get a first look at the order flow. Imagine playing poker and your competitors are able to peer over your shoulder.
What Lewis exposes is outrageous, but hardly surprising. Skimming pennies is a lucrative business because so many investors are willing to play into the game. I say that because so many investors are habitual traders these days. They simply can’t stand still.
If you go back to the late 1990s, a very heavy trading day on the New York Stock Exchange was one billion shares. Today, a heavy trading day approaches four billion shares. high frequency traders account for much of the volume increase, but many institutional and individual investors play into their hands through excessive trading. By doing so, they enable HTF firms to skim $20-billion from investors each year.
I’m here to tell you that you can combat this scam. The most obvious and effective way is to force yourself to stand still: buy high quality stocks and hold them. After all, if you’re not trading, there’s nothing for the high frequency trading firms to skim.
The good news is that buying and holding quality stocks is more than a defensive strategy to protect your wealth. It’s also an offensive strategy for building great wealth.
I recommend buying and owning high quality dividend-growth stocks like Coca-Cola (NYSE: KO). You don’t need to trade in and out of Coca-Cola shares. You can simply buy the stock, collect your dividends, and watch the share price gradually rise.
In the 2010 Berkshire Hathaway annual report, Warren Buffett reveals just how powerful a strategy buying and holding a quality dividend grower is. Buffett offered his insight on Coca-Cola in the Berkshire Hathaway’s (NYSE: BRK.a) 2010 annual report:
“Coca-Cola paid us $88 million in 1995, the year after we finished purchasing the stock. Every year since, Coke has increased its dividend. In 2011, we will almost certainly receive $376 million from Coke, up $24 million from last year. Within ten years, I would expect that $376 million to double. By the end of that period, I wouldn’t be surprised to see our share of Coke’s annual earnings exceed 100% of what we paid for the investment.”
So in time, Buffett expects Coca-Cola to return 100% each year, every year. But here’s another consideration: In 1995, Coca-Cola shares were trading at $14 a share, split adjusted. Today, they trade near $40 – that’s a 185% increase. All that wealth, and not one high frequency trading firm has skimmed a dime.
This effective strategy of buy-and-hold can be taken a step further by investing in a dividend reinvestment program or DRIP. Through these programs, dividends are automatically reinvested through the company. Most DRIPs allow you to reinvest commission free – thus by-passing the broker and high frequency trading scam. As an added benefit, some DRIPS even allow you to buy at a discount to the current share price.
To protect your wealth, you need to understand how the game is played. For this reason alone, I consider Flash Boys a must-read. We want to send you a free hardcover copy of Flash Boys: A Wall Street Revolt (retail price $27.95). Through a special deal with the book’s publisher, we’ve secured just 500 copies of Flash Boys for our Income & Prosperity readers.
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