Let's Reintroduce Some Positive Friction for Investors
Recalling my last article, shareholder churn is up, long-term investing is down, and the structured removal of trading friction for investors in financial markets has proven to be a significant factor with unexpected consequences.
Isn't Removing Friction a Good Thing?
Short(ish) answer - More efficiency is generally good for financial systems but has proven detrimental to decision-making processes that help prevent impulsive trading.
If we go back down memory lane to ECON101, we'll remember that efficient financial markets are a goal for financial economists. They ensure information is distributed fairly, and asset prices reflect this information accordingly.
Barriers to entry or exit, information asymmetry, and transaction costs. These are all forms of market friction that impede efficient trade that most economists consider harmful in a broader sense. This makes sense; an experienced investor who wants to open or close a position should be able to do so cheaply and quickly with minimal friction.
The Rise of the Retail Investor
Having no friction to trade is similar to having no training wheels on a bike. The individuals with experience and self-control will ultimately be self-accountable, but newer and typically greener demographics don't fare quite well when left to their own devices. A lack of relevant knowledge combined with the rising trend of ‘get rich quick’ reveals itself in over-indexations into risky strategies that disproportionally expose retail investors to market risks.
Look at how many zero (or minimal) fee and micro-brokerage offerings exist, which enable investors to set up and trade various securities and positions without a particularly developed level of financial knowledge. This broker ‘race to the bottom’ to capture a new tranche of inexperienced investors has magnified adverse trading outcomes, which understandably are skewed towards retail investors.
SCIENCE FACT: Studies have shown an uptick in impulsive ‘heuristic-driven’ trading from these retail investors, suggesting that trading barriers force a measure of 'deliberative thinking' in the investors that require it most. This effect is most apparent in the rising retail demographic, consistent with the characteristics of inexperience and a younger generation who don't weigh all the available information before making investment decisions.
Let's Re-Introduce Some Positive Friction
Brain science aside, think about it like this.
If market frictions no longer realistically force retail investors to consider available investment information before making a churn decision, what will?
These days, online communities dictate substantial levels of influence on retail shareholders and their trading decisions, as like-minded individuals bounce ideas off one another in an echo chamber of sorts to justify their positions. You only have to look towards the rapid rise of meme-stocks, cryptocurrencies, and speculative options trading with the meteoric rise in their related communities to validate the power of this influence.
Validation, justification and reassurance. These are things that retail investors crave when engaging with these communities. While market frictions may have been a source of deliberation in the past, it now falls on someone to fill that gap with proactive shareholder engagement and education.
Who is better than the issuer themselves?
Engagement precedes trust; trust evolves into attachment, and attachment introduces an emotional trading inhibitor. All other factors being equal, if I have two companies I'm thinking of selling, the one that I trust will be the last to go (if at all). If they release negative news, I'm more likely to read the full announcement or ask questions on how to deal with the update.
A Message for Issuers
Leverage your shareholder's inherent needs for justification and validation surrounding their investment decisions and build a community they can reliably turn to in times of crisis.
Start with engagement, develop trust and nurture shareholder attachment. In a potential shareholder churn event, even minor amounts of friction can exhibit incredible leverage, which may be the difference between losing a shareholder or retaining a long-term holder.
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