The Wall Street Guarantee

Many investors unwittingly abide by Wall Street's rules of engagement, thinking it's the only way to make money. But the Wall Street Wise actually guarantee Average Joe investors like you and me only one thing: that our interests matter less than their profits.

Wall Street is where the big dogs -- Goldman Sachs, Merrill Lynch, JPMorgan Chase -- play. But they play a game that's designed to give their banks all of the money, leaving you holding an empty wallet.

The wingtip crowd has a long track record to support that claim. For instance:

• They focus on the big money and do whatever they can to support those relationships. Their attention and research is geared toward deep-pocketed institutional clients, not average Americans with their retirement cash. When they overwhelmingly gave Intel (NASDAQ:INTC) a "strong buy" rating right before the tech bubble popped, the Street crowd was hoping to make the institutional folks some fast cash. But when the bubble burst, we were the ones who suffered.
  

• They maximize their own returns at the expense of individual investors. Wall Street firms make enormous profits from their venture-capital departments. So when they invest in a small, high-growth company, they'll often delay the IPO to get in on the action before they actually open the company up to the public. They tried to do this with former Motley Fool Rule Breakers pick Overstock.com (NASDAQ:OSTK), but the company withstood the pressure. Instead, Overstock's management -- in what was described as a maverick and foolhardy move -- issued the IPO via a Dutch auction, which leveled the playing field for small investors.
  

• They can make markets. There is a supposed wall between research and investment-banking departments at the Wall Street firms, but if you look closely, you'll see the fine print. Even on analysts' research reports, you'll often find that a company "makes a market in this security." By recommending positions in stocks in which they make a market, the Wall Street firms make money -- and analysts get higher bonuses. Remember that next time you see recommendations for EDiets.com (NASDAQ:DIET) at a valuation that robs even the biggest investors. Yes, the company has caught on to the convenience of Internet delivery for diet foods and fitness programs, but is it really going to grow at its current rates long enough to justify the expectations that are baked into its current price? Many of the Wall Street banks want you to think so, but they get money no matter what you do.

Unless you're among the minority of Americans with "high net worth," you're Wall Street's last priority.

Don't play by those rules
Understand that analyst recommendations are focused on the short term and geared toward big investors. Because analysts' performance is measured on a quarterly basis, they need to predict only three to nine months into the future.

Take a look at the analyst antics for Motley Fool Stock Advisor recommendation Disney (NYSE:DIS). You'll see that many of the banks flip-flopped back and forth on their recommendations, even over a short time horizon. In the case of Disney, one firm went from "hold" to "sell" to "hold" to "sell" in a little more than six months.

While this doesn't show a swinging pendulum between "buy" and "sell," it does point out the flip-flopping and short-term thinking that plagues analyst recommendations. Our Foolish view is that market fears and negative outlooks over a few months don't necessarily cause a deterioration in long-term fundamentals. Conversely, if a company has you worried, why not just keep it a hold until you're totally confident that it's a buy? Short-term timing simply tempts fate. And then there are the taxes and trading costs associated with short-term thinking! The system is set up to punish those with no patience.

For another example, take a look at the opinions for Google -- an analyst went from "sell" to "hold" to "buy" in fewer than four months! Sure, Google's share price was moving, and these could be considered moves based on valuation, but I'm not sure a 17% drop suddenly makes Google a buy.

This phenomenon is even visible in established companies with proven track records such as Hewlett-Packard (NYSE:HPQ), Motorola (NYSE:MOT), and Wal-Mart (NYSE:WMT); analysts' recommendations for all three changed in fewer than six months.

My investing timeline is longer than that. I hope yours is, too.

Be contrarian
It's difficult to buy in the face of a downgrade. We all fear losing money. But your portfolio will thank you if you can escape the short-term Wall Street cycle. One way to do this is to buy stocks that Wall Street doesn't even bother following.

Fool co-founder David Gardner did this when he recommended Marvel Entertainment to Motley Fool Stock Advisor subscribers in July 2002 -- when not a single analyst was covering the stock. Since then, Marvel has returned almost 450%. Take that, Wall Street!

Guarantee yourself better returns
The only way to guarantee better returns is to invest your money with a person you trust completely. Many times, that person is you.

That's why we at The Motley Fool advocate that you take control of your own investing destiny. If you'd like you get started on this path, be our guest at the Motley Fool Stock Advisor newsletter free for 30 days. You'll find ideas that directly contrast the Wall Street state of mind: a long-term investment horizon, full disclosure, and discussion boards that give you the courage to be contrary. Those ideas are earning subscribers of Stock Advisor a pretty hefty profit -- an average return of 50% compared with the market's measly 15%.

Wall Street wants to maximize its returns; you want to maximize your own. Put Stock Advisor to work for you today.

This article was originally published March 3, 2006. It has been updated.

Fool sector head Shruti Basavaraj guarantees that they don't have Cake Day, a monthly Motley Fool occurrence, on Wall Street. Shruti does not own shares of any company mentioned. Wal-Mart and Intel are Inside Value picks. JPMorgan is an Income Investor selection. The Motley Fool'sdisclosure policyis guaranteed.