Recently I’ve noticed a disturbing trend — there are quite a few efforts at play to make investing and growing wealth more difficult for independent and small-time investors. I first learned about one such approach when reading the Freedom Founders newsletter, written by my wise friend David Phelps. The article is from March of this year, when the whole saga of GameStop’s stock was dominating investing news.
It helps to know the whole situation in context: to summarize, a group of young people on the WallStreetBets forum on social media site Reddit decided to play with the market by boosting the stock of declining game and entertainment corporation, GameStop. When the Redditors had learned that some big hedge funds had placed shorts on GameStop, one of them jokingly suggested that Redditors band together to do a short squeeze to make the hedge funds lose money on the trade. This person was very surprised when the forum members did just that, an effort unofficially spearheaded by financial analyst and investor Keith Gill.
At the beginning, everyone was supposed to buy short-dated call options around the same time to push the stock up. This is a much riskier way of investing in the stock market than buying the stocks directly, but it makes a bigger impact on the market price. Anyone who knew anything about the stock market knew that they were probably going to lose all of their money on this trade and nobody was supposed to put in more than they were comfortable losing. It was clear that if they pushed the price up, it would eventually go back down. However, if they could squeeze the hedge funds out of their short positions during the rise in price, it would be considered a mission accomplished.
Their efforts made GameStop’s stock increase by more than 400% in just a week. Then, some big funds and firms decided to step in. One example of this is the investing app Robinhood, which implemented limits to GameStop trades and increased their margin requirements. In a rare moment of solidarity, U.S. politicians from all parties agreed that Robinhood had overstepped and infringed upon “free market trading.”
David uses this scenario to make the case for how Wall Street “elites” — like those big funds and firms — will do all they can to manipulate the market so the rest of us can’t prosper. He writes:
“Wall Street leverages the investment capital of the individual investor. Nobody complains when the market is up as everyone makes money. It’s when the market resets that individual investors lose, often handsomely. The big money funds short their losses with millisecond computer information that provides access to trade movements in advance. Fair? No one said life is fair.
This is the sort of phenomenon that occurs in the late stages of what has now become the longest market bull run in history. The stock market is like a casino. The hedge funds are the house. The small investor is the ‘mark’ (weekend gambler). The SEC is the security that watches and bounces the few who find a gap in the system (Reddit raiders). Congress is the mob paid protection money to let the casino operate and look the other way.
The system is rigged to protect the interests of the elite.
The problem is that the financial institutions, the government, and corporations heavily influence the markets and curtail individual investors’ ability to create real wealth. They provide inefficient, traditional advice like tax savings on a 401k and compounding for accumulation that benefits them far more than you, the individual investor. They tell you to buy financial products that don’t create wealth but make you believe you’ve done something prudent. Guess again. That’s an abdication, not orchestration.”
Then, not long after I was reading that, I learned about something far more drastic: a proposal that would take away the right for people to use their individual retirement accounts (IRAs) to invest in private funds (like ours). In September, the House of Representative’s Ways & Means Committee proposed changes to how IRAs can be used for investment purposes. This is a problem not only for funds like ours, but for anyone who wants to use their Self-Directed IRA (SDIRA) to grow their wealth — which is the whole point of saving for retirement. Although I fail to see the logic in this proposal, the committee’s angle is that the government would get a bunch of extra tax revenue that they’d put toward social programs. What they are actually doing is making it as difficult and confusing as possible to be productive and efficiently save for retirement.
Here’s why their proposal won’t work: At the end of the day, people are just going to produce less wealth. While the government will end up with a larger share of the pie (the tax base), the pie itself will shrink enough to more than offset the benefit from the tax increases.
Another potential change to how Roth IRAs specifically can be used is also in the works. It’s not clear yet as to whether a Ways & Means Committee proposal from late September will only be for those that have $10 Million or more in their Roth IRAs or everyone with a Roth IRA, but we’re keeping an eye on the news to see how this develops. As of late September, the House & Ways Committee did approve legislation from Democrats that “prohibits use of the mega-backdoor Roth conversion” starting in January 2022, as well as a proposal to eliminate “Roth conversions of after-tax contributions to traditional individual retirement accounts” (according to the Wall Street Journal). A “backdoor Roth” strategy refers to participants in 401(k) plans who can put up to $58,000 into their 401(k) account, after taxes, and convert a portion of that to a tax-free Roth account. This is a strategy used by individuals and also corporations like Microsoft, Amazon, and General Electric, among others.
I was talking to Jim Dickson, our economics wizard who heads Multifamily Acquisitions here at Hughes Capital, and he brought up another angle to all of these complicating efforts, which is investor accreditation. Accreditation is a well-intentioned system that, essentially, just controls who can and cannot build their wealth through investing. So while anyone can invest in the stock market without being accredited, the stock market is at an all-time high and an extremely risky place to invest right now. And yet the government will only allow accredited investors to invest in most alternative investments. As we firmly believe, and have researched for more than a decade, alternative investments are one of the best ways to diversify a portfolio, decrease volatility, and increase returns long term. Fortunately, a couple of recent changes have lowered the bar for gaining accredited investor status in the U.S. In an ideal world, this restriction wouldn’t exist at all. Ultimately, the less the government — and the “elite,” as David puts it — can meddle in investing, the better off the rest of us will be.
What You Can Do
As of mid-October 2021, the SDIRA proposal hasn’t yet been voted on, which means there is still time to reach out to your representatives and make your feelings known. Here’s an overview of the two bills in question and how they may affect you, according to IRAFinancialGroup.com:
Bill Section 138312: The proposed legislation would prohibit IRAs from holding privately-placed equity and debt securities and other investments that require the IRA owner to meet certain minimum financial, educational, or licensing requirements. For example, the legislation would prohibit IRAs from holding unregistered investments that are offered to accredited investors, like equity or debt investments in small businesses or investments in private funds.
Bill Section 138314: The bill would also prohibit IRA owners from investing in (1) non-publicly traded entities in which the IRA owner and related entities (including the IRA itself) own more than a 10% interest or (2) any entity in which the IRA owner is an officer or director, regardless of ownership percentage. By way of example, single-member limited liability companies or any investment in an entity in which an individual is a director or officer could no longer be held in an IRA. IRAs holding any of the above investments would lose all of the tax advantages previously available to the IRA.
Here is how to contact your U.S. Congressional Representative:
• House of Representatives: House.Gov/Representatives/Find-Your-Representative
• Senators: Senate.Gov/Senators/Senators-Contact.htm