The Rise of Retail Investing

Five ways to think about retail investing in 2021

The smart money is piling into online brokerage startups. Are picks and shovels where the real money is at?

A trading app shows shares of GameStop during the January rally.
Shares of GameStop shot up during the January rally.
Photo: Clay Banks/Unsplash

This story is part of "The rise of retail investing," a Protocol Manual. Read more here.

VCs see it as a hot space

Investors are piling into new brokerage startups as well as fintech companies with stock-trading features. VCs recognize that younger investors are more likely to gravitate to a slick app than a fancy building. With no real network-effects moat in the retail brokerage business, brand, trust and scale are crucial. Funding for online brokers or related companies totaled $6.9 billion over the past five years, according to Crunchbase; Robinhood accounts for more than four-fifths of that total, having raised over $3 billion this year alone. Meanwhile, big banks such as Goldman, Citi and JPMorgan Chase, eager to catch the latest emerging trends, are betting big on a variety of capital markets and wealth management startups working on new ways of providing securities issuance, trading, clearance or personal investment tools. Since it's so easy to start an online brokerage these days, the picks-and-shovels crowd may end up making the real money.

Tech can make the stock market feel like even more of a casino — but it can also provide safety nets

The VIX, a standard measure of stock volatility, stayed high for most of 2020, and it's only recently started to cool down. Wild swings in meme stocks have contributed to the sense of unpredictability. The chaotic edge to the markets is attractive to some, and the ease and cheapness of trading on upstart apps has added to the Vegas feel. Many new investors haven't experienced a prolonged decline in share prices. When inevitably they go down, investors who aren't diversified will feel the pain. But some of the same features that have drawn gamblers to the market are, if used correctly, good for novice investors. Fractional share purchasing and no-fee commissions mean they're on the hook for less if they experiment. Holly Myer had just started investing through Public a few months ago when she followed the lead of other investors and bought a stock that was "kind of shooting up." She put in $5 and lost it all in a day, she told Protocol. "Even now, I don't truly understand what the company did. What I learned is I actually need to do more research."

Free trading does have a cost

Two decades ago, E-Trade and TD Ameritrade stole online investors from staid brokers with cheap trades. Then a new generation of investing apps built for the mobile world one-upped them. Robinhood unveiled its no-commission trading app in 2014 and most big brokerages followed its lead a few years later. But free trading isn't exactly free: The brokerages have to make money somehow. Robinhood does it through small fees paid by market makers to the company for executing customer trades. This has become controversial, since it gives Robinhood an incentive to encourage members to make more trades. and it's not clear if customers get the best prices in trades. Public, another trading app, dropped this system, called "payment for order flow." The Robinhood rival is now asking members for tips and is planning to add subscription features. Most brokerages also make money lending to customers — which means they have an incentive for them to take on debt, and hence risk.

Regulators are raising red flags

The GameStop controversy led to a House Committee on Financial Services hearing where members grilled Robinhood CEO Vlad Tenev on the company's practices and business model. "Look, I'm sorry for what happened," Tenev said. Saying sorry likely won't be enough. Federal and state regulators as well as industry bodies are hotly debating what to do. FINRA, for example, told Sen. Elizabeth Warren that it is considering whether social features in trading apps like leaderboards might constitute "recommendations" by broker-dealers. The SEC, meanwhile, is considering whether the rise of social media has left "gaps" in existing regulations around market manipulation. The trading apps' marketing and customer acquisition tactics could also face scrutiny. In his legal complaint against Robinhood, Bill Galvin, the Massachusetts commonwealth secretary, blasted the startup's "aggressive tactics to attract new, often inexperienced investors." And Reuters recently reported that Robinhood failed to report some trades — a lapse that, while small, shows how online brokerages need to tighten up their operations.

The robots will step in when traders get tired

The surge in self-directed investing might not last. Already, retail investors' trading activity has slowed from its GameStop peak. Some might be burning out after experiencing losses and the stress of volatility, while for others, the entertainment value might be waning as lockdowns ease and they can go out to movie theaters and restaurants again. This leaves an opportunity for roboadvisors, which offer diversified portfolios and mitigate risk for a fee. Betterment recently acquired WealthSimple's U.S. accounts, Goldman Sachs began offering Marcus Invest and Merrill Lynch dropped its minimum account size to $1,000.

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