New Young Investors
The combination of historically low interest rates, a remarkable long-term stock market performance, and the availability of new, low-threshold modern investment platforms, has resulted in a strong influx of young investors to the stock market. The sudden price dip at the beginning of the corona crisis and the perceived chances to get into the market “cheaply” have further intensified this development. The increase in stock market participation has several consequences not only for individuals but also for society at large.
Let us start with the positive aspects. Modern technology made investing in the stock market and other assets easier, cheaper and quicker than ever before. The decreased barriers to entry allow larger segments of the population to access financial markets, even with relatively low investment amounts, and thus to participate in economic growth, and potentially decrease societal wealth inequality. Market access can not only directly improve financial well-being but also financial literacy and, more generally, the interest in and understanding of finance and economics. This ultimately leads to better informed consumers who might be less vulnerable, and an increased democratization of financial markets. These prospects are vital when considering the current situation for young people. Everyone who, over the last decade, has neither been invested in the stock market nor possessed real estate has effectively lost substantial purchasing power. Young people suffer from this the most as they have been completely lacking the possibility to participate in this growth. The consequences we see in (among other places) the housing markets, where starters have huge difficulties purchasing an appropriate house or apartment despite the low interest rates. Hence, next to other political measures, the described new development can help to improve the situation of many and prevent further pressure on social security systems.
The devil lies in the details though. Young investors’ investment behavior is driven (next to lacking investment experience) by some fundamental changes in the modern investment landscape. First, many young investors get their investment advice nowadays from various social media channels, including so-called finfluencers. The quality of these channels has an enormous heterogeneity in quality ranging from excellent to scam. Unfortunately, attention-grabbing sensational “advice” and “hot tips” will be heard much more easily than dry but necessary facts. Second, there is a recent trend towards social trading platforms where investors can observe peers’ trading and holdings. This typically highlights certain extreme portfolios of a few traders, and it is hard to disentangle luck and skill. As a result we observe excessive risk-taking behavior of many inexperienced traders. Third, a number of new platforms make use of gamification in their investment apps, “rewarding” their users with confetti glitter etc. when they have made a successful single trade. Reward is important, and there should be much joy in life, but here it mixes up a serious investment strategy and replaces it with speculative, often wealth-reducing, short-term trading. Research shows that a vast majority of investors on these social trading platforms lose money. Last but not least, trading costs were lowered substantially to almost zero with the unfortunate side effect that the mental effort investors put into their decisions, and therefore the investment decision quality, suffers. Our empirical analyses demonstrate, for example, that trades done via the smartphone are, on average, worse compared to those made on a computer by the same individual. In sum, if we look into the typical portfolios of the new investors, we very often observe under-diversified and risky positions as many new market entrants concentrate a large fraction of their portfolio into a small number of medially salient companies or cryptocurrencies.
Taken together, while increased stock market participation comes with a series of benefits for individuals and society at large, this new development entails some risks in the way it happens at the moment. A large fraction of new young investors will make bad experiences with their first investments. While mistakes are the steps to success, we can hope that newcomers are not discouraged but find their long-term strategy that fits their own preferences, so that they can benefit from the new opportunities in a rewarding and sustainable way.