The past two years has played host to a retail investing revolution across investment markets. Following the development of payment-for-order flow online brokerages and the release of government stimulus packages in the wake of the pandemic, we’ve seen a remarkable rise in the volume of retail investors trading their money on stocks and shares. But is this new wave of adoption as inclusive as it seems?
The stats don’t lie. Retail investors are arriving on the market in record numbers, and the trend’s impact has been felt across Wall Street.
We’ve seen investors congregate on online forums like r/WallStreetBets to generate a short squeeze on GameStop and AMC stocks to send their shares rocketing into the stratosphere, and we’ve seen daily equity share volumes surpass their previous peak, set in the midst of the financial crisis of 2008.
Image: Financial Times
As the table above shows, the average daily volume of US equity options traded climbed to more than 40 million contracts in early 2021 – indicating an accelerating trend of growing trading activity from retail investors.
Image: IAMAdvisory
One of the most significant developments that paved the way for this rise in retail adoption was the introduction of zero-commission operating models for online brokerages.
As the chart above shows, from their introduction in late 2019, we’ve seen daily average trades accelerate by as much as 200 per cent in the case of some brokerages, whilst Robinhood’s monthly active users climbed from less than 5 million to more than 20 million between Q4 of 2019 and Q1 of 2021.
However, the introduction of zero-commission brokerages has been a controversial topic across the investing landscape, as well as the tactics used by platforms to keep their users engaged.
With this in mind, let’s take a deeper look at whether the recent surge in retail adoption really points to the democratization of retail investing:
The implications of zero-commission
As with many things in life, it generally is if something sounds too good to be true. This is certainly the case to some degree with the zero-commission switch that brokerages made in late 2019.
Made popular by Robinhood in recent times, the platform relies on a payment-for-order flow (PFOF) model to make money rather than commissions.
The approach relies on rebates paid by market makers to execute a buy or sell order on their terms. As brokerages opt to use a specific market maker over a more competitively priced alternative, the middlemen pay for the vast volumes of business it receives.
As Robinhood took off with its PFOF setup, other more traditional retail brokers like Schwab and TD Ameritrade adapted to stay competitive.
Image: Bloomberg
Although companies that have adopted the PFOF model claim it provides better prices for retail investors, consumer advocates contest this assessment.
The argument against payment-for-order flow is that it presents a significant conflict of interest for brokers to find the best prices for their users.
In fact, in February, a Congressional hearing in the wake of the GameStop short squeeze event aimed at PFOF, claiming that it was fundamentally to blame for some of the current problems across the investment landscape.
In the wake of the mounting criticism, Robinhood rival, Public.com opted to drop its payment-for-order flow setup in favour of welcoming ‘tips’ from their users instead, as a means of making their trading environment fairer.
Retail brokerages have also been accused of profiting from the gamification of their investing platforms as a means of encouraging greater levels of order flow.
In March 2021, Robinhood opted to remove a feature where confetti would rain down from the screen when investors made their first trade amid concerns that it offered instant gratification for buying stocks through the app.
The path to true inclusivity
Retail brokerages may need to adapt their platforms if they’re committed to truly level the playing field between retail investors and their institutional counterparts.
“Companies can provide protocols for determining which investments are appropriate for new account holders to avoid costly mistakes at the outset,” claims Maxim Manturov, head of investment research at Freedom Finance Europe.
“Firms should also consider additional staff training to educate clients about the risks of investing in high-volatility securities and adopting better methods of dealing with clients during market volatility.”
“Financial institutions could also consider offering information that might be useful during times of turbulence, such as warning labels on equities with high volatility so that customers are aware of the dangers.
“Also, it would be a good idea to add education to reduce the flow of disinformation faced by retail investors online and support investment education, including building VR virtual learning modules with built-in lessons in essential financial concepts,” Manturov adds.
While we’re seeing vast new users arriving across the retail investing landscape, institutions still face many hurdles that institutions don’t have to worry about. The path to true inclusivity can be laid in the future. Still, it may require a new operating model for online brokerages and a greater level of support and education for new investors.
The democratisation of finance is already underway, and with a series of improvements, the future certainly looks bright for the retail investing ecosystem.
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