Early in my career I had a job at what would be considered an “old school” brokerage. Business was done almost exclusively on the phone. We sold stocks on commission. Every once in a while there would be a wise crack from a broker in the room trying to sell a client.
Client: “I’ll pass on this one.”
Broker: “The only people that ever made money passing were quarterbacks and racecar drivers. Let’s pick up 100 shares.”
I didn’t spend much time in this environment. I quickly saw this was not how I wanted to do business. I specifically remember the moment that I knew I was going to leave.
The client coin toss
The group of new recruits, of which I was a part, had a sales manager who taught us the ropes and kept us on track. He was a genuinely nice guy and a hard worker, but one day he said something (without even realizing it) that had a huge impact on me.
“Only about one out of 15 new accounts really become a client. Most people open an account and don’t do much else. Only about 1 of every 15 accounts you open will end up eventually moving over a bunch of money.”
He thought this was just basic straight talk, but I started doing the math in my head.
The company had a system where they tried to do three trades with a client, and after three trades they tried to talk the client into transferring over the bulk of their investments.
What if it was all just random, as I was starting to suspect anyways? What if the chance of any of the recommended stocks going up was a 50/50 coin flip?
If you take a group of 15 new clients, after one trade seven are up and eight are down. Ignore the eight who are down. They will never trade with you again.
The seven who are up think you might know something. They do another trade. Three are up and four are down. Throw away the four who are down. Now you have three people that have had two profitable trades.
These three really think they are onto something. They do one more trade. One client is up and two are down. Discard the two that are down. You have one guy left who has had three profitable stock trades in a row. He thinks you are a genius, worth your weight in gold. He transfers over all his money.
Short-term wins don’t constitute long-term success
My point is to warn against the notion that, with investments, “the proof is in the pudding.” For the one out of 15 that had three successful trades, the proof did seem to be in the pudding. Seeing how this operated from the other side, it is clear how ridiculous it is to put your trust and money in the broker, even if they made money three times in a row.
This may sound strange, but with investments you can’t just follow results – especially short-term results. They can be dangerously deceiving.
Photo by Official U.S. Navy Page