When it comes to investing, retail investors have always been playing a game of catch-up against the big institutional investors. While this trend is not going away any time soon, we should still work towards closing that gap.
Capital! Capital! Capital! - At the end of the day, more capital means more influence, control, access and a greater ability to stay afloat. The greater amount of capital that institutions have is the fuel that enables all their other advantages.
Training and Experience - It is a reality that those who work in the industry receive more education and training than your average individual. Individuals working in the industry will acquire the experience that those on the outside wouldn't have time to.
Access - The vast majority of the general public just doesn't have the access that institutions have. This includes access to investment opportunities, data and research, and the tools and tech that industry professionals use on a daily basis. The number one contributor to this advantage is once again capital!
Knowledge And Research - While this is not true for all individual investors, on average the retail investors lag behind greatly in terms of both their understanding of financial markets and their ability to access the tools to do their own research.
Ability To Manage Risks And Collect Fees For Services - We should not forget that large institutions do offer services for their customers. A good portion of proceeds from these services ends up covering their risk management costs. Retail investors on the other hand use their own money and aren't subject to the same strict risk management policies. This tends to result in investors taking on not only more risks, but risks that they don't fully understand.
I'd like to first state that regulation is of upmost importance towards maintaining the integrity of the market and the confidence in system.
We should always work to improve our regulations, but this does not mean more restrictions every time we encounter a problem. We tend to point to preventative measures as the go to solution, but many times the better path is actually to ease outdated regulations.
Regardless of whether additional regulations add restrictions to retail investors or institutions, they do raise the barriers to entry. This ultimately hinders the retail investor significantly more than institutional investors.
The institutional investors will have the advantage in terms of having the tools to estimate short interest. This will also open the door for big investors to drive up the stock price without enough checks and balances from the short sellers.
Learn about why short selling is vital to financial markets here!
The idea would be that brokerages would have enough funds so that in event of volume spikes, they would be have the liquidity to service all their clients. This sounds good from a risk perspective, but it also means that brokerages are not efficiently utilizing their capital. Brokerages will end up passing on the costs by increasing fees charged to the consumers. Increased fees ultimately hurt the smaller investors significantly more as bigger institutions are better able to average down these types of costs.
By design, institutional investors will always have a leg up because that's what they are being paid to do. Financial institutions earn profits because they have the expertise and resources that most everyday folk don't. This means we have dependence on them, which is the core of the "problem".
One of the major reasons we depend on hedge funds, pension funds, banks, insurance companies is because they offer a service we need. We arguably have come to rely on those services a bit too much. And the main reason for that is the lack of financial literacy in our society.
If an individual understood how to budget and save their money to build their own retirement portfolios, they wouldn't need to put all their faith into their pensions. And thus be able to reduce their dependence on those fund managers.
The same can be said for the actively managed funds that are available to retail investors. Empirical studies have shown that after factoring in the management fees, managed funds have on average been outperformed by index funds. Which raises the question of why so many people still keep investing into managed funds?
Financial literacy is not only about knowledge, but it can also be seen as a mindset. The western education system lacks one of the most important topics that we can teach our kids from a young age. This is one of the major areas that need to be improved.
Personal finance is a topic that has been mostly left as a family responsibility which has resulted in a large portion of people not getting the necessary information. We need to encourage individuals and investors to take interest in the world of investment and personal finances.
As individuals improve their understanding of financial markets and personal finances, they would be able to better identify the options they have. Ultimately we want to move in a direction where institutions will function more as a service for the retail investor rather than a competitor.
