You should fear 'the banksters,' not the stock market

My colleague Ryan Cooper argues that one key factor in millennials missing out on the current stock market boom is distrust in the financial system. Like very many millennials, he is apprehensive about becoming an investor, and cites numerous financial scandals from the past five years as events that have influenced this view:

Actually, he's barely scratched the surface of the whirling maelstrom of scandals that have hit the financial system in recent years. It's probably worse than Cooper suggests. There have been many cases of rapacious banksters coming for the wallets of the naive, the greedy, or the plain unlucky. Say "finance" these days and most people will instantly think of Bernie Madoff or the 2008 crash. (The more learned in this perverse association game might even say "the LIBOR scandal" or "Goldman Sachs betting against its own clients.")

So I can completely understand the fact that lots of people are very distrustful of the financial sector after the last six scandal-plagued years. In many ways, I am too. The financial sector has been sick for a long time.

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Ostensibly, the financial sector's purpose is to act as an intermediary between investors and businesses, to channel money to productive endeavors that produce goods and services that people want. If done well, this can be a valuable service from which all three parties — investors, businesses, and financiers — benefit. Unfortunately, instead of doing that, many firms and individuals in the financial industry took advantage of their position and power to parasitize investors, government, and the wider economy.

But just because the financial sector has been rife with corruption and treachery for a long time doesn't mean that it's wise to forsake investment altogether and just sit on cash, which is what many millennials who have money to invest are doing. Sitting on cash might express frustration and antipathy, but it isn't going to offer decent returns — in the current environment it offers negative real returns, i.e., you lose money to inflation. Nor will it improve the state of the economy, which relies on investment and spending for growth and jobs.

It's wise to remember that investment in "innovative financial products" like mortgage-backed securities — which is how so many people got screwed — isn't the same thing as investment in productive businesses through the stock market. You don't have to entrust your money to bankers and financiers and their complex financial products in order to invest. In fact, the opposite. Instead of trusting financiers who promise to beat the market for you, or sell you complex financial products, you can just buy a simple index fund.

Over my lifetime (I was born in 1987) investment in index funds such as the S&P 500 has been spectacularly profitable, a pattern which has held true for the last 200 years. And these decent returns have happened even though the financial system has been a treacherous mess for a significant portion of that time.

There's no doubt that the financial sector still has a heck of a lot to do to regain America's trust after the worst financial crisis for three generations. But if fear of "banksters" translates into a more general fear of investment, history suggests that the people who will lose out the most will be those who spurn investment and choose to fearfully sit on cash in the bank.