TCS Daily


Main Street Fights Back

By Dominic Basulto - July 10, 2006 12:00 AM

The good news is that nearly 50 percent of all U.S. households now own stocks. The bad news, though, is that the individual investor who directly owns stocks without the use of financial intermediaries (i.e. mutual funds) is a disappearing breed.

Since 1950, direct ownership of stocks by American households has declined from 91 percent to just 32 percent today. At the same time, large institutional investors (pension funds and mutual funds) now hold 68 percent of all stocks, with the largest 100 money managers accounting for 58 percent of all stock ownership. This concentration of control in the hands of a relatively small number of institutional investors is cause for concern. As John Bogle, founder and former CEO of Vanguard, pointed out in an op-ed piece for the Wall Street Journal last year, "The amazing disappearance of the individual stockholder as the backbone of the U.S. stock market has been one of the least recognized but most profound trends of the last half-century."

At a time when "citizen journalists" are disrupting traditional media business models and "citizen advertisers" are coming up with new advertising campaigns for consumer products companies, why has the "citizen investor" yet to make an appearance on Wall Street?

The most obvious reason, of course, is that tens of millions of individual investors have decided that, in the face of the seemingly overwhelming advantages enjoyed by Wall Street insiders, it is best just to sit back and invest passively in professionally managed funds rather than throw good money after bad at the Wall Street casino. As MarketWatch.com columnist Paul Farrell recently suggested in a decidedly negative piece about the declining power of Main Street investors, "The Wall Street juggernaut's in control, and America's 95 million investors are relegated to a footnote in market history, like a museum piece no longer popular, packed away, out of sight, deep in the archive vaults."

Which all might be a bit disturbing, one supposes, if it were actually true. Does anyone really believe that citizen investors are destined to be "powerless non-entities in a land of nothingness," as Farrell suggests? That might have been the case fifty years ago -- or even twenty years ago; but today?

If anything, the individual investor is more empowered than ever before. Thanks to Regulation FD, individual investors know as much as "Wall Street insiders" and have access to the same type of information as Wall Street analysts, including real-time access to conference calls and annual shareholder meetings. Moreover, thanks to the popularity of low-cost online trading platforms, it's now possible to do a formidable amount of research on any financial market in the world, all while sitting at your PC in your pajamas at two in the morning.

It's easy to see why large institutional investors look down on Main Street's "low-margin, nickel-and-dime accounts" -- it's simply too much trouble for these large institutions to deal with anyone who doesn't have a sizable amount of wealth to invest. However, this is exactly why the financial services sector is ripe for technological disruption. Millions of citizen investors with less than $200,000 to invest (the unofficial cut-off for many professional money managers) are looking for investment alternatives that will enable them to minimize costs and maximize returns. Many of these are DIY investors who are actually interested in owning individual stocks. Instead of working on new solutions that will enable millions of these everyday Americans to re-take control of their financial future, though, many large institutions continue to view these potential clients as not worth their time or effort.

Yet all is not lost. Consider, for example, the phenomenal growth in the popularity of exchange-traded funds (ETFs), which are basically super-low-cost index funds that trade like shares of stock, complete with their own ticker symbols. For the citizen investor, they offer a number of important advantages: low costs, broad diversification, tax efficiency and market liquidity. Using an ETF that tracks a broad index such as the S&P 500, it's possible for anyone to create a relatively diversified portfolio for less than $500. Or, should you feel the urge to turbo-charge your retirement savings, it's now possible to invest in ETFs that track anything from commodities to the fast-growing Chinese market. Best of all, since these ETFs trade just like shares of stock, it's possible to trade them through an online brokerage -- just as you would with shares of regular stock.

There are hopeful signs that the investment pendulum is swinging in favor of the citizen investor. Technology and innovation are two powerful forces that are helping to empower the citizen investor and erode some of the advantages enjoyed by large institutional investors. While technology is helping to drive down transaction costs for individual investors, innovative new solutions offer these investors a way to experience the magic of compounding returns without, as Bogle calls it, the "tyranny of compounding costs." The future of an ownership society ultimately depends on the empowerment of the citizen investor, and not the enrichment of the professional money manager.

Dominic Basulto is a TCS Daily contributor who writes frequently about finance and technology. He is also the editor of the Business Innovation Insider.

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1 Comment

Even the 1/3 of a percent per year that the index funds take as a management fee is way too much.
Even the 1/3 of a percent per year that the index funds take as a management fee is 4.16 percent of typical stock market gains (assuming an 8% annual gain which is probably twice as high as the real gain if you include inflation). That is way too much. I would like to see the fund get a percentage of amout that they beat the market index (S&P 500) by. For example if in a year the S&P 500 goes up 8% and the mutual fund goes up 10% the fund management company could get say 1/3rd of 2%. If the mutual fund goes up equal to or less than the S&P 500 the fund management company should get nothing and should not even be reimbursed for their transaction fees because they accomplished nothing.

Since this does not exist the most rational thing to do is buy individual stock through cheapest broker that you can find. Buy in over time until you hold at least 60 stock and never sell until you need the money. Select the stocks as carefully as you can but understanding that it may not matter if efficient market theory is correct. And always be cognizant that stock are about dividends and potential future dividends (stock buy backs that reduce the float are equal to dividends). Do not fall in to greater fool investing.

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