The Stock Market is Disappearing

Discover what this means for your portfolio and investment strategy

Ric Edelman: It's Wednesday, May 29th. On today's show, why the stock market is disappearing and what that means for your investment strategy. All right, here's a quick question for you. How many stocks are in the Wilshire 5,000 stock index? Oh, I know it sounds like a trick question, such as “who's buried in Grant's tomb?” – but no, this is a bit of a trick question. 

How many stocks are in the Wilshire 5,000? About 3,500. Huh? Wait a minute. How could that be? It's real simple. Fifteen years ago, there were 7,500 stocks publicly traded here in the United States, particularly the New York Stock Exchange, NASDAQ, and elsewhere. But so many companies have undergone M&A, mergers and acquisitions, where there used to be two companies, now there's one bigger one. 

Or, companies have been bought privately, meaning all of their publicly traded shares were acquired by a big investment company. And they basically took that publicly traded company and made it private again. Who is that big investment company that did that? It's called a private equity firm. Sometimes also called a venture capital firm. Sometimes hedge funds do this. When you have a publicly traded company purchased by a private equity firm and its shares are no longer traded publicly, they are now held privately by the PE firm, that's a company that's no longer trading on the New York Stock Exchange. 

This has been happening to such a big degree over the past 15 years that while there used to be 7,500 companies publicly traded. Nowadays, it's about 3,500. So Wilshire 5,000, which used to have the 5,000 largest companies in its index, there aren't even 5,000 in total anymore. 

They simply haven't bothered to change the name of their index. They still call it the Wilshire 5,000, even though it only holds 3,500 stocks. What does this mean for you as an investor? Well, we love the idea of diversification. The more investments you own, the lower your overall risks, right? 

I mean, any one company might go broke at any one time, but if you want a hundred companies, a thousand companies, well, the odds of them all going broke at the same time is a whole lot less than any one of them going broke at the same time. So we love the notion of diversification. The problem is there isn't as much opportunity for diversification in the stock market as there used to be, because we now have about half as many stocks today as we had 15 years ago. 

There's also another issue in the world of the stock market. In the old days, a company decided to go public, to make its shares available to the ordinary investors, because the company was trying to raise capital. They needed the money to grow their business. That isn't what happens anymore. Today, companies go public, not because they need to raise capital, but because they want to monetize themselves. In other words, if you look at Microsoft, which went public decades ago, it was a very cheap stock because the company wasn't very big. They needed the money to grow. But today, if a company needs cash, they don't have to become public to get their cash. All they got to do is sell some of their company to a private equity business. 

The private equity investor will give them the capital they need and the company remains private. Which means by the time the company decides to sell its shares on the open marketplace, they're not trying to raise capital anymore. They're trying to cash out. Look at what happened with Facebook when they decided to go public. 

They were already a multi-billion dollar business. They were simply trying to cash in on their investment success rather than trying to raise capital to grow. Which means for you as a retail investor trying to make an investment in the stock market, by the time you get to buy the stock, the company's profits have already been obtained. They're already a hugely successful business. This presents a conundrum for investors. There are not only fewer stocks available for you to buy. There's not as many of them you'd want to buy, simply because of the way they're going public. So, what does it all mean for you? Well, it means you need to pay attention, not just to publicly traded stocks, but privately traded ones as well. 

In other words, making investments not in companies, but in private equity funds that invest in those companies. Private equity funds now own $8 trillion worth of companies these days, twice as much as just six years ago. So clearly we need to be paying attention to this. There's a couple of problems though. 

Number one, investing in private equity is generally available only to accredited investors. In other words, you've got to have a net worth of a million dollars or more or annual income of $200,000 or more to be able to buy these investments. That excludes an awful lot of people. Second, when you do make an investment in a private equity fund, that investment is going to be 7-10 years in duration. 

You are going to have a lack of liquidity during this period of time. That creates a big investment risk as well. And third private equity funds operate like wine, meaning there are vintages. If you invest in a PE firm’s fund of this year, they're going to raise X amount of money. They're going to buy X number of companies. And then next year, they're going to raise another fund to invest in other companies. The companies they invest in with their fund next year are different than the companies they're investing in this year, which are different from the companies they invested in last year, just like wine is different each year with the harvest – you know, the 2018 vintage is a lot different than the 2019 vintage – same thing is true with private equity. If you invest in their 2024 fund, the investment results are going to be very different from their 25 fund or their 26 fund. So you have that risk as well.  

There are a couple of ways ordinary Retail investors who aren't accredited investors can invest in private equity. You can invest in the companies themselves. Some private equity companies are traded publicly. So you can actually invest in the PE company itself rather than in the funds that it's raising money for. And there's a movement to allow these PE investments inside 401k plans. The argument is that ordinary retail investors, the typical US worker doesn't have the opportunity to invest in private equity and therefore they are being denied an investment opportunity that's readily available to rich people and institutions. The argument goes, we should make these investments available to these folks. No better way to do that than to add them to the list of opportunities inside 401ks. 

You can imagine the counter argument. Many people saying these investments are too risky for ordinary investors who don't appreciate and can't afford the risk. We'll see how this develops. My point is this, if you like the idea of owning stocks, and I agree with you, you need to look at the opportunity for owning a broader array of stocks than you can get merely through the public markets. Talk to your financial advisor about this. Odds are pretty good they've tackled this question. They may well have opportunities for you in the private equity, venture capital, or hedge worlds. 

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Ric Edelman: Hey, are you saying “meh” to spot bitcoin ETFs? Join me at VISION, June 2-4 in Austin. Hey, forget about those new bitcoin ETFs – you'll hear about so many other ways that you can give your clients exposure to bitcoin, like direct-purchasing and crypto SMAs. VISION is the perfect event for networking. Register today at DACFP.com, the link is in the show notes. 

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Ric Edelman: On tomorrow’s show, we will talk about T+1 trade settlements for securities transactions. 

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