A great financial economist once tried to convince me that retail investors should not be allowed to buy individual stocks. I strenuously disagreed: Wasn’t this America, the country that encourages risk-taking? Why shut regular investors out of the chance to get rich?
I have now come to realize that he has a point. Most people don’t know what they are doing. Buying individual shares, as this professor argued, is like buying a spark plug for a car; it is only useful as a part of a whole, in this case a diversified portfolio. Most retail stock-pickers will underperform the market.
I realize that there are already many financial regulations that try to steer investors to better decisions. These safety precautions go beyond the finance industry, and they exist not just to impose a nanny state. The government is justified in restricting risk if an individual’s decisions pose harm to others (that’s why there are speed limits), or if they are unable to acquire the information necessary to make an informed choice (that’s why there are rules about food labels).
To some extent, investing in individual stocks meets these criteria. Retail investors have less money and time to do research than the big institutional investors they are betting against. If they just buy index funds, they benefit from a rising market. But when they day-trade, they are locked in zero-sum game where their small size puts them at a disadvantage. This natural inequity can sow distrust in markets.
Yet the idea of banning individual stock-trading never left high-minded discussions in the faculty lounge because this kind of trading was never a big problem; few people did it. It took time and effort, like phone calls to an actual stockbroker or a visit to an actual office. Now things are different. You can day-trade on your phone while waiting for your coffee at Starbucks.
It’s not just stocks. Lots of risky financial behavior is being normalized or even encouraged, thanks not only to technology but also to new regulations that blur the distinction between investing and gambling.
Access to private assets was once restricted to accredited investors, who have at least $1 million or professional expertise; now you can invest your 401(k) in them. Legal gambling once required a trip to Las Vegas, or maybe a casino on a Native American reservation; now you can bet from your phone as the game is played. And the list of things you can bet on is almost endless: the next CPI report, how much it will snow tomorrow, the color of Gatorade poured on the winning coach at the Super Bowl.
