For a long time, Garrison Keillor hosted a weekly variety show on Public Radio called A Prairie Home Companion. It was set in the fictional Minnesota town of Lake Wobegon, “where all the women are strong, all the men are good-looking, and all the children are above average.”
If you think about that sentence, you will realize very quickly that nothing about it could possibly be true. The definition of average means that all the children cannot be above average. And while it’s less of a mathematical falsehood, in any town of more than a few people, all the women won’t be strong and all the men won’t be good-looking.
But the sentence is appealing. Why? Because it plays into our desire to be special. We all want to feel special. Marketers know this, so even though we know that we can’t all be above average, marketers do their best to make us all feel that way.
What does this have to do with investing?
Investing in stocks, bonds, mutual funds, and the like is done in public markets. These investments are heavily regulated, as are the exchanges they are traded on. Buying a stock, bond, or mutual fund is a pretty straightforward process that’s available to everyone with even a little money to invest.
But private investments are a different matter. These are generally not available to the public, and that makes them seem a bit mysterious and, well, special.
To invest in a private security, you actually do have to be somewhat special. With only a few exceptions, the SEC requires that you have a yearly income of at least $200,000 or a net worth of at least $1 million in liquid assets. And even then, you have to know someone.
So just to qualify to invest in a private offering means that you are special. There are exceptions, but even those exceptions make you special because you have to meet certain other criteria, including knowing someone involved in the offering.
Here’s a hypothetical example. Joe down the street, who’s been a neighbor for years and is a good friend, has a business that’s doing well. One day Joe tells you that his company is expanding and they could use a little money to fund it. This is what I mean by knowing someone.
And even though no one said, “You’re special,” you now feel that way.
Or let’s say Nancy (another hypothetical person), an old friend from school, works in the private wealth department of a big financial firm. She tells you that they have a private deal that she is only allowed to offer to a limited number of people. Everything she is telling you is true, and it all implies that you are special. You’re an insider. And that’s a problem.
Why? Oh, so many reasons. For one thing, there’s a tendency to get excited when you realize that you’re being offered an investment opportunity that isn’t available to just anyone. That emotion can lead to investing mistakes. You might leap at this opportunity without doing the necessary research.
Don’t underestimate those emotions. They are powerful. That’s why almost every brand has some way to make you feel special. We are wired to keep doing things that make us feel good, and feeling special tends to be one of them.
But there’s so much more. Private investments have one huge disadvantage compared to public investments. If you make an investment in any mutual fund or buy any publicly traded stock or bond, you can sell it in a very short time. If you make an investment and have buyer’s remorse, in some cases you can sell it in a nanosecond.
If you invest in something that’s publicly traded and a week later you find out that you need that money, you can sell it.
In most private investments, you don’t get to decide when to sell. Suppose you invested in our hypothetical friend Joe’s company, and a week later you find out you need that money. Joe has already put your money into his business. Unless he’s willing and able to give your money back, there’s nothing you can do.
Suppose after years of doing well, Joe’s company takes a bad turn. Sales start dropping. He’s laying people off and you’re worried the company might be headed for bankruptcy. You’d like to get your money out, but there’s nothing you can do. There’s no public market for a private investment.
This last problem is more common than you might think. A lot of private offerings are private because the companies involved are too small to efficiently launch a public offering. The failure rate of small businesses is far higher than that of large, publicly traded companies.
And now we come to why these investments are only offered to special people— which mostly means wealthy people. Regulators consider private investments to be much riskier than public investments—and I concur. So for the most part, only people wealthy enough to afford to take losses are allowed to invest in private investments. That’s it. The reason you’re special in this instance is because you can afford to lose money! Are you saying “no thanks” yet?
Hal Masover is a Chartered Retirement Planning Counselor and a registered representative. His firm, Investment Insights, LLC is at 508 N 2nd Street, Suite 203, Fairfield, IA 52556. Securities offered through, Cambridge Investment Research, Inc, a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Investment Insights, Inc & Cambridge are not affiliated. Comments and questions can be sent to email@example.com These are the opinions of Hal Masover and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. Investing involves risk. Depending on the types of investments, there may be varying degrees of risk. Investors should be prepared to bear loss, including total loss of principal. Past performance is no guarantee of future results.
Indices mentioned are unmanaged and cannot be invested in directly.