Investing goes mainstream, thanks to apps and stimulus checks
New investors, here’s what you need to know before you hit the trade button.
Young investors, especially millennials, are betting that trading stocks and options at low or no commission in a rising bull market is an easy way to make money. But some investing experts fear the opposite.
Apps make it easy
Easier market access, enticing apps and low commissions have brought in many novice traders and have helped drive the bull market, defined as a market trend in which the economy is sound and on the rise. But in markets dominated by veteran professionals armed with the latest analytical technology, new investors could be facing some hidden risks.
This doesn’t mean that novice investors should sit on the sidelines, but just like an open bar offering free drinks, new investors need to know where to draw the line.
If you’re new to investing, here’s what you need to know and what you should look out for.
What pitfalls do new investors face?
The stock market plunged in the spring of 2020, creating enticingly low stock prices, and then began to rebound. The enticing decade-long bull market was back in gear. Multiple brokers saw the numbers of accounts and trades spike near the turnaround, CNBC and others reported.
It’s no secret that the 2020 markets were affected by a very rare convergence of economic, public health, monetary and political crises. As the COVID-19 virus spread across the US starting in late winter, it led to layoffs, business closures and the creation of a new work-from-home labor class.
Novice investors stuck in COVID quarantine with extra time and money also got help from easy-to-access, commission-free brokerage accounts. Both established and newer fintech stock brokerages advertised a wide variety of enticements and features for new investors.
Many large brokerage firms, including Fidelity, E-Trade and Vanguard, attracted traders by charging low equity commissions. Online fintech firms made investing even cheaper and easier with fractional shares, pre-packaged portfolios, low management fees and zero commissions. Online firms specifically designed for millennials, such as Stash, Acorns, SigFig, Personal Capital, Robinhood and Motif Investing, helped raise interest in trading as well.
Robinhood was a game changer
In Robinhood’s case, the firm broke new ground when it waived commissions entirely for its options and equity trading. This helped it grow to 13 million user accounts. With easy-to-use online apps and no commissions, the door to the stock-options market was opened to millions of new investors.
But all this attention drew the scrutiny of regulators. Critics suggested Robinhood “gamified” trading, encouraging excess, especially through its app. In some cases, investors making their first trade were greeted with a shower of confetti on their electronic screen, the Washington Post reported.
Robinhood’s customers might be victimized by professional traders, some news reports suggested. In a complaint filed in December 2020, the Massachusetts Securities Division claimed Robinhood exposed Massachusetts investors to unnecessary trading risks by falling far short of the fiduciary standard adopted this year for broker-dealers. In some cases, this meant that traders could lose more than their original investment either in terms of market losses or being forced to add new money within days into their accounts to meet margin calls.
A Robinhood spokesman pushed back, saying, “We are committed to operating with integrity, transparency, and in compliance with all applicable laws and regulations. We’ve also made significant improvements to our options offering, adding safeguards and enhanced educational materials.”
Options trading is a concern
Some newer investors are moving into the riskier options market, lured by the promise of controlling a larger number of shares than they can afford to buy outright. Nine of the 10 busiest trading days on US options exchanges since options trading began in 1973 occurred in 2020.
Options are leveraged investments that allow traders to buy and sell blocks of stocks for a relatively low price. Buying a call option gives the buyer the right, but not the obligation, to buy full shares in a company at a specified future time and date. If the stock rises above a preset strike price, the call holder can sell the option at a profit. If the strike price isn’t hit, the investor can let the call option expire and lose only what he or she paid to obtain the option.
Put options give the trader the right to sell the stock at a set time in the future. Puts work like calls, but gain in value when the stock price declines.
For example, Amazon (AMZN) goes for about $3,200 a share, but an option contract on 100 shares of Amazon might cost a few hundred dollars. Options pros say they’re no riskier than stocks if you do your research, but it takes a lot of study and time to determine which options are worth the risk.
The options markets offer a wide variety of strategies, but the current boom is in the riskiest: speculating on single stocks. In 2020, about 8.7% of all options trades were single trades of one contract, a sign of small traders speculating on the market, according to TradeAlert data.
What opportunities exist in the bull market for new investors?
If you’re new to investing, chances are you’ll want to stick to buying and trading the brand-name stocks that dominate the news. A quarterly report prepared by Apex Clearing found that the top 10 stocks held by millennials were Apple, Amazon, Facebook, Disney, Boeing, Tesla, Netflix, Alphabet, Berkshire Hathaway and Advanced Micro Devices.
These are all great core long-term holdings. But they’re also big, established companies with stable stocks. It’s tough to make money with these except over the longer term. Aggressive traders who want rapid growth traditionally have traded lower valuation, smaller cap companies such as those in the Russell 2000 Index of small-cap stocks.
What investing resources should novices consider?
With so many new investors entering the market, it pays to get some professional financial advice. The good news is that there are many free online and in-person ways to discover the benefits of long-term investing.
If you want advice, quite a bit of free advice about the mechanics of options, stock, ETF, and commodity trading is available from the exchanges themselves. They have libraries of professionally written and unbiased how-to guides about how their markets –– and the instruments traded on those markets –– work.
For options, go to the Chicago Board Options Exchange.
For futures and commodities trading, go to the Chicago Mercantile Exchange.
For foreign exchange (forex) trading, go to Forex.com.
If you want to speak with an investment professional, consider going to a licensed Certified Financial Planner (CFP) or the National Association of Personal Financial Advisors by entering your zip code. You can consult with a CFP on an hourly basis and can find a CFP in your area by going to the sites listed above. Ask how much they charge and prepare a list of questions to stay focused. There is no obligation to buy anything from a CFP, but if you do, make sure they are not charging commissions on any products they sell.
At the meeting, the CFP will ask questions about your age, investment experience, portfolio size, dependents, net worth, financial goals and risk tolerance. These are many of the same questions you would be asked if you went to a full-service, discount firm or robo-advisor to open any new account. All of this information will be used to help construct a model portfolio, comprised of stocks, mutual funds, ETFs, and bonds.
Investing is a marathon
Building wealth isn’t easy, and student debt, job losses due to COVID pandemic restrictions and a volatile job market have all disrupted the best plans people made. This also explains why only one in five millennials has an investment account at all, and nearly half of Americans don’t own a single stock, according to Gallup.
Stocks are a great place to start, particularly blue chip stocks, but a financial advisor can help you establish a diversified portfolio comprised of index-tracking exchange-traded funds (ETFs) and mutual funds. A single S&P 500 ETF gives you a piece of those 10 top stocks mentioned above and many more. That’s less risky than holding shares of just 10 stocks, and it costs a lot less to get started.
If you’re new to investing, don’t be intimidated, but take advantage of the educational tools available to you to make the best investing decisions.