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.The means we should use to close that gap should be through education, not regulation.
Capital! Capital! Capital! - At the end of the day, more capital means more influence, control, accessibility and a greater ability to stay afloat. The immense 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 investor. Industry workers will acquire skills and experience that those on the outside wouldn't be able to.
Access - The vast majority of the general public just doesn't have the access to the tools that institutions have at their disposal. This includes access to investment opportunities, data and research, and the technology that industry professionals use on a daily basis. The number one contributor to this advantage is capital.
Knowledge And Research - While not universally true, the average retail investor lags behind in terms of 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.
First, it is important to recognized that regulation is of upmost importance towards maintaining the integrity of the markets and the confidence in system.
We should continue to improve our regulations, but this does not mean pushing out 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 We tend to point to preventative measures as the go to solution, but many times the better approach is to ease outdated regulations.
Whether additional regulations are intended to restrict retail investors or institutions, they will raise the barriers of entry for everyone. 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 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 may end up passing on the costs to the consumers through higher fees. Increased fees ultimately hurt the smaller investors more as bigger institutions are better able to absorb 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 retail investors don't. This means many people ubiquitously end up depending on them, which is the core of the problem.
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 one of the main reasons for that is the lack of financial literacy from a individual level.
An individual that understands budgeting, saving money and building their own retirement portfolios wouldn't need fully rely on their pensions. And thus be able to reduce their dependence on those pension 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 on average are 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 is also about the mindset. The Western education system currently lacks one of the most important topics that we can teach our kids. This is one of the major areas that need to be improved.
Personal finance is a topic that has been delegated as solely a family responsibility. This has the result of a large portion of the population not getting the necessary education. We need to encourage individuals and investors to take interest in the world of investment and personal finances.
As individuals improve their understanding of both personal finances and financial markets, they would be able to better armed with the tools make their own financial decisions. Ultimately we want to move in the direction where institutions will function more as a service for the retail investor rather than a competitor.
