Welcome to the age of the empowered individual investor. These days it seems like everybody and their brother, cousin, and dog have their eyes glued to the ticker and their hands on the mouse. There are more individuals in the market, armed with more information and able to place trades more cheaply and more easily than ever before.
The internet is in large part responsible for the fervor and frenzy that has consumed more than a few retail investors. But have the internet and electronic trading fundamentally changed the way individuals invest? The answer is both yes and no. US retail investors are trading more frequently, and contributing more to overall market volatility, in some cases to an extreme degree. But at the same time retail investors trade less frequently than many institutions and can at times contribute to market stability. Increasingly, evidence shows that the internet is just another channel for investing, and for gaining access to information and cheap trades. It is not transforming the bulk of retail investors into fire-breathing madmen.
Individuals represent a greater slice of trading activity than ever before. According to the most recent data from the New York Stock Exchange, the number of individual investors (including individuals with assets in mutual funds or retirement plans) rose 33 percent to 69 mn in the six years from 1989-1995, and the numbers keep rising.
The massive swings in Nasdaq high-tech and internet stocks have largely been due to individuals looking to make a fast buck. Even on the NYSE the proportion of non-block trades (an indicator of individual trading) has risen to 50 percent of average daily volume, up from 43 percent in 1995.
Online investing is making deep inroads into the territory of traditional full service accounts. Current estimates of online accounts range from 3.7 mn, according to Forrester Research Inc, to Gomez Advisors’ 7.5 mn. (These numbers may seem high because one individual may have multiple accounts.) Everyone concurs that the number of online accounts will skyrocket in the next few years. International Data Corporation projects over 24 mn accounts by the end of 2002 and Forrester projects 20 mn by 2003.
Day trader myths
Right now there is little hard data on individual trading behavior, which has led to many misperceptions. Probably the most overblown worry is that day traders are taking over the market. ‘Just like anything else in the world, the vocal minority get all the print,’ says Rick Baggelaar, associate publisher at Investor Media Network. ‘Everything you see about day trading is true, but it is getting overblown in terms of its impact on the overall situation.’
Richard Wines, senior managing director at Thomson Financial Investor Relations, believes the day trading fad will start to fade out soon for a simple reason: day traders tend to lose money. Indeed, even if they trade successfully, which many do not, by the time they pay their commissions and taxes often they make little or no profit.
The vast majority of online investors are not day traders but investors with online accounts do tend to trade more often. According to a survey for the Securities Industry Association by Yankelovich Partners, computer-using investors who place trades via the internet trade an average of 17 times a year, that compares 13 trades a year for non-internet traders.
At E*Trade, the average customer trades 24-30 times a year, or two to three trades a month. Though that number is much higher than the typical full service customer who trades about six times a year, it is nowhere near the levels of day traders.
The bull market’s dizzying heights combined with the ease and fun of making transactions online could push full service customers ‘up to seven or eight trades a year but eight would be a hell of a leap,’ says Forrester Research’s James Punishill who just completed a study on net investing. ‘But it’s not going to jump from six to twelve.’
Click-happy newcomers
Another factor in increased internet trading is that new internet traders tend to place more trades when they first open an account. E*Trade’s Lisa Nash, vice president of customer management, describes it as an educational period during which investors want to try out the account. ‘They have made a decision, I want to buy stock X and I want to buy it online,’ says Nash.
They may also have a backlog of changes they want to make in their portfolio, and as they realize it is cheaper and easier online, they feel they can get started. Nash says the initial jump in trades tends to move down as customers spend more time with research tools and exploring what’s going on.
Is the lure of clicking ‘ok’ so seductive that it draws in investors and causes them to trade more often? Perhaps. But it is very clear that online investors are not suddenly tossing their entire strategy out the window. Rather, online investors have always traded more frequently.
In its analysis of net investing, Forrester Research has broken investors down into four categories. The two types of active traders, called ‘aggressive affluents’ and ‘get rich quick’ make an average of ten transactions a year. These groups represent less than 20 percent of the total investing population, but comprise 70 percent of all investors trading online today.
As the internet has become more mainstream, so has the online investing category. Since many of the most active investors have already moved online, in the future the lion’s share of new online investors will come from the two more passive types of investors. These groups, ‘retirement by the book’ and ‘portfolio cruise control’, trade 0.7 and 2.8 times a year, respectively. Forrester predicts they will represent 79 percent of new online investors in 2003. This suggests that the upcoming waves of new online investor will be much more conservative and hold for much longer than the earlier waves.
The higher number of transactions in online accounts is likely also because many people have more than one account, one with a full service broker and another electronic trading account. Simple economics makes it quite likely that turnover would be lower at the expensive full service brokers, says Terrence Odean, finance professor at the Graduate School of Management at the University of California Davis. ‘In their mind they are separating this chunk of money they don’t want to touch and other money they will deploy as it moves them,’ says Chris Musto, senior analyst at Gomez Advisors. E*Trade’s experience supports that idea. E*Trade’s Nash notes investors tend to move their money into online accounts slowly. They are not necessarily trading more, but E*Trade is getting more of their trades.
Downward slide
Despite these factors that partially explain the higher levels of transactions in online accounts, individual investors on the whole do seem to be somewhat more speculative than in the past, but not as much as many think. The biggest trend in individual investing is the ongoing move toward mutual funds, which behave very differently from individual investors. According to Thomson Financial Investor Relations, direct individual ownership has been slowly sliding downward for a long time. Individuals now own only 30 percent of the average large-cap company, compared to 40 percent in 1990. And the trend toward investing indirectly is likely to continue, especially as more electronic brokers offer mutual funds in their listings.
According to Forrester Research, in 1999, 68 percent of assets in online accounts were in equity and only 32 percent were in mutual funds. Forrester estimates that by 2003, 50 percent will be in equity assets, 40 percent in mutual funds, and 10 percent in fixed-income.
Individual investors may feel that with the bulk of their money invested in mutual funds, the remaining assets can be invested more speculatively as the riskiest portion of risk capital. Certainly, the speculative urge is driving a huge amount of individual trading activity in IPOs and internet stocks. Electronic investors in particular tend to have a very high weighting in internet stocks. Their enthusiasm for internet shares makes sense when you consider that they trade online and are excited about the medium, says Musto. And how can one resist the temptation to be a part of the most dizzying sector run-up in history?
Steady fundamentalists
Yet somehow, not everybody is getting swept up by dot-com fever. At the National Association of Investors Corporation, which advises three-quarters of a million individuals belonging to investment clubs, the mantra is fundamentals. The average hold time is 7.5 years and that has been steady over the past ten years. According to CEO Ken Janke, ‘Our people pay less attention to quarterly numbers and look more to the long term. If a stock has been growing at 15 percent we don’t get upset if it has some problems and grows at 13 percent. Up to the minute news means so much to institutions but less to individuals.’
While contributing to volatility in the IPO and internet sectors, retail investors have at the same time been a stabilizing force on the market. Individuals have been major buyers of stocks that have plunged drastically in value as institutional investors sell out following major earnings disappointments or corporate crises.
As NAIC’s Janke notes, ‘Our members see disappointments as opportunities.’ This was especially true during the 1997 market correction, where the quick recovery was primarily due to heavy buying by individuals as the index fell. Yet the idea that individual share ownership dampens volatility – often regarded as a market truism – has never been the case, according to Wines. ‘Our research still shows that valuation and volatility are much more directly related to the mix of institutional owners rather than to the proportion of individual holders,’ writes Wines in a recent TFIR newsletter.
The bottom line is that the internet is just another channel to invest. The low cost, ease and fun of trading over the internet may increase the frequency of trading, lowering hold times somewhat, but it does not fundamentally alter the overall strategy of individuals. As E*Trade’s Nash put it, ‘People don’t suddenly become risk takers at age 55.’
Ravenous appetite
There are, however, several important implications for IROs. First off, the newly empowered individual investors have a ravenous appetite for information. At E*Trade on volatile days investors tend to be on site longer than usual. They are not necessarily trading more, but just watching their portfolio, especially if the market is going down. They are also far more willing to call the company directly to ask questions. At Iomega, which is over 70 percent retail-held, director of investor relations Tyler Thatcher says when there is a sudden movement in the stock price that investors don’t understand they are more willing to call the company and ask. That can significantly increase the load on the IR team. Thatcher says he sometimes gets over 100 calls in a day.
IR officers are also dealing with a breed they are not used to: the clueless investor. Mark Koenig, director of investor relations at Rentech, Inc and a former broker, was shocked when he first started getting calls from the clueless in 1998. ‘I would get calls from people saying they had read about the company on the internet and had bought some of your stock. Now what do you do?’ Others would ask about the company stock, ‘Should I buy it or sell it?’ The more individuals rely on online trading and less on the advice of full service brokers, the more it becomes a direct relationship between the investor and the company, with the IRO taking the place of the broker, says Koenig. ‘It changes investor relations from serving just the institutions to serving customers. Investor relations has to become more like a retailer’s customer service department than a traditional IR department,’ adds Yannis Bakos, professor at New York University’s Stern School of Business.
It can be a battle to stay on top of disclosure requirements, and many investor relations officers are quite nervous about shareholder suits. ‘Shorter horizon investors may be more likely to be involved in these lawsuits, because they didn’t buy in or sell out on some news,’ says Bakos. ‘It’s the people moving in and out quite quickly that I guess are the most likely to be litigious.’ Rentech’s Koenig agrees, and believes federal regulators may eventually be forced to step in to protect public corporations from shareholders.
Armchair CEOs
In addition to dealing with a larger number of clueless investors, IROs are increasingly confronting more openly opinionated individuals than ever. ‘There are a lot of armchair CEOs out there waiting to let us know how they think the company should be run. I get e-mails every day about how to run the company,’ says Iomega’s Thatcher.
At the end of the day, do all these factors change the ideal shareholder mix? Nobody really knows. Most IR departments are still focused on institutions for the same reason as Iomega’s Thatcher: they are easier to deal with. Yet the aura of at least apparent stability in retail investors still calls companies like Intel which has quintupled its individual shareholder base through a concerted effort in recent years. Rick Baggelaar, who has discussed the question of mix with hundreds of people over the years, says the collective wisdom normally centers in on 50-50, and common sense dictates that a mix should still be in that general ballpark. ‘But maybe that’s just a cop-out,’ he quips.
