I usually don’t post about current events because the daily news cycle has very little relevance to mindful investing, which is practiced and measured in terms of decades.  Events that appear ominous as they unfold almost always fade into insignificance in a few weeks or months as this chart from JP Morgan nicely illustrates.

With that sort of lead-in, you’re probably thinking this post should be about Russia’s ongoing invasion of Ukraine.  Indeed, a hot war in Europe involving nuclear saber-rattling is potentially far more consequential than any of the events in the above graph.  A possible exception is when COVID started and huge uncertainties raised the specter of a coming plague-like dystopia.

But I think it’s far too early to even attempt a rational assessment of how the war in Ukraine might impact our investing plans, although that doesn’t stop financial news pundits from breathlessly speculating as each new event unfolds.  If you want to know my thoughts about unlikely but catastrophic investing risks in general you can read my post on Investing Disasters and Deep Risk.  Almost everything I say in there applies pretty well to the worst-case scenarios for Ukraine and Europe right now.

Instead, I’m posting today about the ongoing efforts to pass a new law banning members of Congress from trading individual stocks.  Although the debate on Congressional stock trading has almost no bearing on your and my long-term investing plans, it nicely highlights some key concepts of mindful investing.

What’s The Issue?

Members of Congress are routinely inundated with potentially useful business information that’s not available to most investors.  And they routinely make decisions that directly impact myriad business and financial interests in the U.S. and abroad, whether that’s through sponsoring new legislation, setting committee-level priorities, voting to pass bills out of committee, or voting on new laws.

So, members of Congress face the inevitable temptation to misuse their legislative power and privileged information when trading stocks, which is one form of “insider trading“.  Although the Stop Trading on Congressional Knowledge (STOCK) Act of 2012 prohibits members from insider trading, it’s extremely difficult to prove a link between a specific trade and specific privileged information.  Although no official record of punishments under the STOCK Act exists¹, it’s been widely reported that no member has ever received any substantial punishment for Act violations beyond paltry late reporting fines of $200.

Is It Really A Problem?

The absence of any meaningful punishments is startling given some of the widely known cases of suspicious trades and potential conflicts of interest by members of Congress recently.  Here are a few examples² chronicled by Business Insider and others:

• Nearly 75 lawmakers held stock in COVID vaccine makers Moderna, Pfizer, or Johnson & Johnson while making decisions about Federal support for vaccine creation, production, and distribution.
• At least 15 members of the Armed Services Committee have money invested in specific defense contractors.
• Senators Burr, Inhofe, Feinstein, and Loeffler (whose husband is chair of the New York Stock Exchange³) dumped millions in stocks after receiving COVID briefings and before the stock market collapsed in March of 2020 due to COVID concerns.
• At about the same time, Senator Paul’s wife bought stock in Gilead, which makes the antiviral drug Remdesivir, and Senator Malinowski invested nearly a million dollars in medical and tech companies that had a stake in COVID response.
• Senator Perdue conducted 2,596 trades in his 6-year term (equivalent to 20 trades per day!) including suspiciously well-timed plays on vaccine makers and a casino company at the start of the pandemic.

Perdue also traded 10 stocks in industries under the purview of Senate committees that Perdue was a member of.  The performance of these 10 stocks from his time entering the Senate in 2015 to April 2020, at which time he sold most of his stock holdings, was 14% annualized.  This return handily beats the 8.9% annualized return of the S&P 500 in this same period as shown by this graph of the growth of one dollar from Fortune.

Many of these allegations were at least briefly investigated, but only Burr is still under investigation, which highlights the difficulty of proving insider trading even when the trades are as suspicious as these examples.

Clearly, the trading of individual stocks by members of Congress is a real problem.  And the obvious solution is to limit their investing to either blind management by financial professionals and/or broad index funds that automatically don’t favor particular industries or companies.

All by itself, the strength of Congressional resistance to a ban seems like circumstantial evidence that members know they unfairly benefit from privileged information, and they simply don’t want the feeding trough taken away.  When asked late last year why a ban is not being considered, Speaker of the House, Nancy Pelosi, gave this weak excuse: “We are a free market economy.  [Members] should be able to participate in that.”  Of course, the question is not whether members should be able to participate in free markets, it’s whether they should have easy access to a hugely unfair advantage in those markets.

Stock Picking Is Normally A Loser’s Game

Beyond such circumstantial evidence, mindful investing principles suggest that picking individual stocks on a level playing field is a complicated loser’s game in comparison to no-fuss index investing.  Here’s a summary of the facts supporting that contention from previous Mindfully Investing posts:

• A Longboard Funds study found that in the period from 1983 to 2006 about 75% of all U.S. stocks collectively had a total return of 0%.  All of the gains of the stock market came from just 25% of the best-performing stocks as shown in this graph.

• Researcher Hendrik Bessembinder found that less than half (42%) of all U.S. stocks were able to outperform short-term Treasury-bills (the risk-free asset) from 1926 to 2015.

• Another study by JP Morgan of individual stocks in the Russell 3000 index from 1980 to 2014 found that two-thirds of the stocks underperformed the index, the absolute returns were negative for 40% of the stocks, and the median return for individual stocks was negative 54% as shown in this graph.

I conjecture that most members of Congress likely already know that stock picking is difficult.  After all, extrapolating from 2011 statistics, the average net worth of Congressional members today is around $9.5 million.  So, most of them know a thing or two about investing money either directly or through some sort of financial adviser.

And all advisers and most retail investors know that index funds exist because beating the market through stock-picking is such a difficult task.  Just the other day, I saw a television commercial that said, “Why take single-stock risk?  Invest is XLF index fund.”⁴  The concept that stock picking is a risky endeavor is such common knowledge that advertisers use it to sell their fund products.

So, if most of Congress has some sense that stock picking is at best a difficult task and at worst a sucker’s bet, why would they be so afraid of losing their access to stock market gambling?  I suspect that most members of Congress know they have access to privileged information, and deep down they have a hidden desire to use that information for unfair personal profit.

Ignorance Is No Excuse

On the other hand, it’s almost assured that some members of Congress are honestly unaware of such details.  But that fact leads to even better reasons to ban stock trading by Congress.  Such ignorant investors could be more likely to misuse privileged information either accidentally or purposefully.  And they might also be less aware that using such information is inherently unfair.

It’s also possible that some members know about the difficulties of stock-picking but fancy themselves as savvy stock-picking geniuses.  But in that case, why do they have such a dire need to trade stocks while in Congress?  Why not resign and make a killing in the stock market?  If they want to be public servants instead of billionaires, then why not let service to the public take precedence over personal profit, regardless of whether Congressional trading is fair or not?  Again, I suspect that deep down most of these would-be stock geniuses know that a successful profession as a stock trader is far harder than the lucrative⁵ and powerful careers they already enjoy.

Conclusions

The kicker to all this is that even with copious insider knowledge, beating the market is still pretty hard.  Beyond evaluating the 10 stocks where Senator Perdue had a clear conflict of interest, Fortune also estimated the performance of Perdue’s entire portfolio of stocks while he was in the Senate as shown in this graph.

Even with access to insider information and the willingness to make 2,596 trades in six years, it appears that Perdue substantially underperformed the S&P 500 and only made a slight gain over this period.

I’m sure Perdue would say this evidence just shows that he wasn’t using privileged information to make investing decisions.  But the more plausible lesson is that beating the market is hard even when you cheat.  Perhaps if more members of Congress understood that cheating doesn’t always work, they’d be more willing to pass a Congressional stock trading ban.

---

1 – To this, I have to say, holy crap!  The existing laws don’t even require a clear record of who’s been punished for what under the STOCK Act!  That law seems truly useless.

2 – After reading these select examples, you might think I’m biased against one party or the other or scrutinized the House less than the Senate.  However, these examples were the ones that I found most quickly after conducting a few internet searches.  No bias is intended because it seems that this problem is endemic to both parties and both houses.

3 – Holy crap again!

4- This is not an endorsement or advertisement for XLF.

5 – Members of Congress receive pretty ordinary salaries.  But if you consider all the perks of being a legislator along with subsequent opportunities for high-paying jobs like lobbying and company board seats, it’s a pretty profitable long-term career move to get elected to Congress.