The recent volatility of GameStop stock and limitation of purchasing some stocks in January by some brokerage firms has sown confusion and mistrust in the way that the stock market functions. The rise of “free” trading mobile apps and fractional share investing have made the market more accessible to a large number of younger investors, who may be able to greatly benefit from market participation.
Congress is revisiting how these “free” trades are free, whether trading apps have introduced “gamification” into investing in a way that underplays the risks involved, the danger of misinformation when it comes to investing, and what can be done to ensure a marketplace free of fear of manipulation that everyone has access to.
Arvest Wealth Management has received questions on these issues recently from seasoned investors and those new to the market. Many wish to discuss the possible dangers with their children as they dip their toes into the market. Our client advisors would be pleased to elaborate on how we address them as an institution with you or your children and relatives.
Here are some brief answers a client advisor could elaborate on.
- What are “Meme” stocks?
- Meme stocks are stocks that have been the focus of attention on social media, and have built sentiment and interest around them from shared observations. A meme can be bullish or bearish and contribute to that trend, and it doesn’t necessarily mean it’s a good or bad stock, merely that a lot of people are interested in it. Meme status is likely to increase the volatility in the stock price, so additional caution should be taken prior to investing. The increased volatility may also cause fear of missing out, which may cause someone to invest prior to doing all the research they normally would.
- Do “free” trades create a “gamification” of the market?
- Because “free” or discount brokers make more money when there is a greater amount of trade volume, a potential conflict of interest has been raised as to whether those platforms are promoting day trading behavior.
Being a day trader isn’t a bad thing, some will be very good at it, but the proportion of successful day traders to successful long-term investors is not one to one. The “gamification” concern is that an easy user interface that reduces barriers to trading encourages emotional investing behavior and makes it more likely that a potential long term investor will engage in day trading behavior on an impulse and end up worse off.
Consider the difference in barriers trading now to 30 years ago –
- The difference in the amount of time one might spend researching a stock, if they had to buy a lot of 100 shares vs. a lot of less than 1.
- The likelihood that one would buy or sell a stock when it when up or down when they had to place a phone call vs. just clicking a button on their phone at all times.
- The desire to jump in or out of a particular stock when discussing it with a few others or reading analysts vs. hearing the sentiment of what seems like the entire investment community all at once.
None of these are necessarily bad things, but all this access may lead to a lot of micro decisions, and the market noise can create stress many investors prefer to avoid. It’s important to realize that one doesn’t need to day trade to be a successful investor. In fact, most successful investors are not day traders. One doesn’t even need to choose individual stocks. There are many different kinds of securities, and bonds, and funds that might be appropriate. Every investing platform should provide free education and information on researching stocks and understanding trading, and a client advisor could also help explain prior to making decisions. Investing doesn’t need to be impulsive.
- These apps allow for fractional share trading. Are there any differences between a fractional share and a full share, aside from dollar amount invested?
- Yes. Fractional shares are not a new concept, but in the past they would come from mergers, splits or dividend reinvestment programs since trading fees were too large to make them worthwhile in their own right. They have some drawbacks which still exist to some degree even though entry and exit are much easier. Some of these drawbacks are:
- A limited selection – not all stocks trade fractionally
- possible liquidity and transfer speed issues – brokers will add fractions up to execute a trade
- possible loss of shareholder voting rights depending on your broker
- inability to transfer shares – some brokers require that you cash out fractional shares if you wish to transfer an account
The “free” or low-cost trading approach with fractional shares may allow diversifying a portfolio or access to particular stocks at lower cost. When considering diversification and exposure to groups of stocks, one could also consider a mutual fund or ETF without incurring some of the drawbacks of fractional shares.
- How are these brokerages making money when their trades are “free”?
- Don’t be afraid to ask your broker or bank how they make money. We love that question! It gives us the opportunity to let you know how we justify the value we provide.
Often when receiving something for “free” in a phone app, it turns out that free means “Ad-supported”. You are giving up your time or attention, in return for the content being provided at no additional cost, and the money for the app maker comes from another source so the user may be considered the “product” instead of the “customer”.
One way that discount or “free” brokerages are making money is by a practice known as “Payment for Order Flow” first pioneered by Bernie Madoff (yes, that Bernie Madoff). Instead of handling the execution of the orders themselves, they route it to market makers and take a small portion of the “spread” the market makers capture for doing so. A market maker is legally obligated to provide “best execution”, but Congress is looking into whether or not this is the win-win-win scenario it’s purported to be, and whether or not “free” trades actually cost less in aggregate that traditional commission trades. A payment model that earns based on increasing order flow may have a conflict of interest regarding whether or not it promotes day trading.
That’s great! We’d be pleased to elaborate, click to setup a meeting with a client advisor here.
These recent inquiries may seem a little unusual, but Arvest Wealth Management is a full-service brokerage so we handle all kinds of questions regarding wealth management beyond providing investment advice. Questions such as:
- Should I be worried about tying up my money in the market?
- How should I measure how much risk I should take on? What’s a time horizon?
- What are the advantages of different types of IRAs? How much money do I need to retire?
- How much insurance does a family usually take out when a new child is born?
- How can I ensure the maximum benefit both for a charity and myself when making a substantial gift?
- What steps can I take to create a lasting legacy for my children, grandchildren, and beyond?
A DIY model may be a great starting place to learn for a young investor, but it can be helpful to get a second opinion when wealth management becomes more complex and one is dealing with big life transitions. Arvest Wealth Management Client Advisors are eager to answer questions about our traditional full-service brokerage model, or our self-directed trading model for investing with clear transparent pricing.