To say the investment industry has been disrupted is an understatement. COVID-19 has created wild swings in the stock market and it seems the news changes on a daily basis, making it nearly impossible to predict what will happen next. Despite a long bear market, we’ve experienced market disruptions before. Perhaps even more concerning for individual investors, from a long term perspective, is the disruption taking place at the industry-level.
You can argue that it first began several years ago with the rise of Robinhood and fee-free trading. It certainly gained momentum in the fall of 2019 as we watched one industry heavyweight after another bow to the pressure to eliminate commissions. Beyond changing the fee-structure, however, the industry is also undergoing significant consolidation. Charles Schwab announced its plan to buy rival TD Ameritrade, while Morgan Stanley has made an offer to buy E*Trade.
As these Wall Street elites jockey for market dominance, while balancing the uncertainty brought about by a global pandemic, it begs the question of whether consolidation is good for the individual investor or is the industry effectively taking a giant leap backward?
Taking advantage of current market conditions
First, though, for both high value and novice investors alike, there are important considerations during a dropping bear market. With the unexpected market changes due to the COVID-19 pandemic, interest rates are suddenly at an all-time low and the stock market has seen dramatic dips that offer a wealth of possibility for smart investors.
For example, it is the rallies after bear markets make up most of the gains over the years. These rallies offer the advantage of “convexity” which is a fancy way of saying that the recovery is a much bigger percentage than the loss. For example, if the market sells off by 1/3 (33.3%) and then you invest, you can make 1/2 (50%) if it returns to its previous high. However, you have to be a patient investor who doesn’t take on too much risk because of the potential for high volatility.
This is why a bear market presents a particularly good time for new investors. Novice investors can patiently add to their long positions a little each week and should focus on not being fully invested until the market is down more than 30%. As it’s difficult to predict the best entry position, or when the market will transition between bear and bull, the best advice is to maintain your discipline and hold onto your long positions for the long-term.
Moving away from Main Street
The next question then becomes, how best to make those investments? For a while the market was moving toward a Main Street-mentality, opening opportunities for even small investors. However, when you consider the combined entity of a Morgan Stanely/E*Trade, with eight million customer accounts and $3.1 trillion in client assets, it’s hard to imagine those small investors will carry the same value high volume traders do.
~Novel Serialisation: Heavens Fire~
The traders being swallowed up in this consolidation are those who were deliberate in choosing their brokerages in the first place. Smaller, self-directed investors value easy-to-use trading and charting tools, and easy-to-understand advice. They may not be using a financial advisor to manage their transactions and therefore want the tools required to do it on their own.
The Wall Street elite, however, has long serviced more affluent customers, who rely on expert advisors to handle transactions. In the case of Morgan Stanley, its purchase of E*Trade and other acquisitions have been a purposeful strategy to reach less affluent clients. Without the robust capabilities and agility of a digital upstart however, it will be a challenge for Morgan Stanley to meet the needs of these investors, especially Millennials and younger.
Too much tradition, not enough transparency
For most of the 200+ years of trading stocks, it’s been a rich man’s game. Fees on even one transaction could range in the hundreds of dollars before the SEC finally stepped in to deregulate commissions in 1975.
This spawned the birth of discount brokerage firms, and trades costing $70-$100 dollars felt cheap. Commissions steadily dropped over time, dipping below $20 in the 1990s and prior to Robinhood’s launch in 2015 averaging somewhere around $5-$8 a trade. Robinhood came in to offer fee-free trading and it felt like a novel breath of fresh air.
Traders flocked to Robinhood, believing their ‘no fee’ approach made them more honest and transparent. When it was exposed just how much Robinhood was making from trader activity, investors felt blindsided and betrayed.
It turns out that it’s not just about saving money on trades. Customers today are looking for greater transparency from all companies they do business with, and brokerages are no exception. The Wall Street elites were virtually backed into a corner to meet the no-fee trading requirements. None seem eager to jump on a transparency bandwagon, though, one that would finally allow investors to understand just how brokerages make money off of their investments.
Free does not mean fair
With the spotlight trained on the investment industry as of late, traders are growing more aware that free does not equate to fair.
Many of the investors who flocked to online and discount brokerages did so because the larger investment firms could not meet their needs. Now as the industry consolidates, these investors will likely be swallowed up by the very policies and procedures they actively wanted to avoid.
Even the so-called disruptors have failed to create a truly level playing field, one where investors of all sizes have an opportunity to take advantage of the market in the same way. Free trading, with little education or insight behind it, can be downright dangerous. Without understanding the very real consequences of trading, it can feel a bit like gambling and lead to reckless, rushed investing choices. Brokerages have a responsibility to educate and support investors and provide that level playing field, which requires clear communication and direct connection.
In our digital era defined by ultra-transparency, the trend is to give more to your customers and take less of the lion’s share. With industry consolidation happening so rapidly, and the potential for anti-trust conglomerates to form, it’s hard to imagine that providing fair, transparent and educated trading practices will be at the top of the list for Wall Street.
This is why disruptors will remain so important: to challenge the status quo, address the unique needs of average traders, and keep the fat cats on Wall Street from creating another environment that devalues and discredits everyday, Main Street investors.
By Alan Grujic, CEO of All of Us Financial
