The rise of retail investors

The so-called ‘democratisation’ of finance, driven by cheap, easily-accessible, low-cost trading platforms as well as a surge in free time, seems to be well underway.

Take cryptocurrencies. The massive gains in these digital, blockchain currencies that are created, managed, stored, and traded on computer systems is one of the earliest and most notable examples of a market trend led by retail investors. It wasn’t until 2020 that mainstream professional investors began to take part.

While many professional investors fretted over the economic damage being unleashed by COVID-19, retail investors were also quick to pick the bottom of the market when stock markets sold off in the spring of 2020.¹ They quickly, and correctly, took the view that central banks and governments would pull out all the stops to come to the rescue of their economies, and financial markets.

Their share of the market is also notable. Retail investors accounted for as much as a quarter of US stock-market activity in the first half of 2020, up from just ten per cent in 2019, according to one source.²

Retail investors’ ability to shape events was perhaps most vividly illustrated in January this year, when a $13 billion investment company, Melvin Capital, was left with huge losses after amateur investors, coordinating via part of the Reddit social news aggregation and discussion website, pumped up the share price of troubled video-game retailer GameStop more than twentyfold.³

The new-found power of retail investors has important implications for professional investors. The latter need to be alert to the possibility that the stocks they hold may become targets for retail investors. It now makes sense to monitor what is happening on message forums such as WallStreetBets. It is also wise to look at a wider set of data to seek signs of unusual activity before investing in a stock.

There are reasons to believe this might mark the start of a more permanent trend. Few people now have access to generous company pensions and most rely on their own savings to fund their retirement. Younger people may also wish to take a more hands-on approach to managing these savings, unlike older generations who were content to cede control of their money to professional investors. The recent success of retail investors may also lead to a permanent rise in the number of people managing their wealth more actively, especially given the sharp fall in the cost of trading stocks in recent years.

However, although retail investors may appear to have the upper hand at present, aided by massive government support for financial markets, they might want to bear in mind there is no shortcut to financial success.

While some individuals, through luck or judgement, may have made sizeable returns having bought and sold shares at the right times, latecomers hoping to ride the wave will not have been so lucky. Long-term financial success will continue to depend on selecting the right stocks at the right price, and that is a complex process requiring the ability to undertake skilled and detailed analysis of a wide variety of factors.

Yet professional investors should also be aware of the power of retail investors as a force, and where necessary adjust their own actions. Since it seems the amateurs may not have been quite so naive after all, it may be time to show them more respect.

Three points to remember

• Individual investors, known as retail investors, have enjoyed considerable success in financial markets recently and appear to have a growing influence, a trend that may continue.
• Long-term success in financial markets still requires the skills, knowledge and resources that professional investors can call on.
• Nonetheless, professional investors should be alert to the new-found power of retail investors when making investments.