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Investment Barriers Once Seen as Insurmountable are Falling Fast
The 2020s Could Become the Most Inclusive Decade for Investors
(Note: companies that could be impacted by the content of this article are listed at the base of the story [desktop version]. This article uses third-party references to provide a bullish, bearish, and balanced point of view; sources are listed after the Balanced section.)
Barriers that a short time ago prevented the average investment account from access to the same benefits that larger institutional or high-net-worth accounts took for granted are crumbling. There were a number of doors opened from regulators, online brokers, financial advisors, and investment research providers toward the end of the last decade. If they keep opening, it will change the investor playing field. Together they give investment advisors, self-directed investors, and other financial professionals the ability to provide lower cost, higher quality, and more flexible service, to far more people.
Toward the end of the last decade, four big advancements leading to a more inclusive environment by Wall Street occurred. As they’re adopted or more broadly accepted, smaller investors will have more options, and investment advisors will have an increased ability to serve their clients.
Keeping more of their money is the surest way for any investors to net a higher return. If the same nominal cost per transaction is applied to a large order, versus a small order, the percent cost of the transaction fee is much different. For example, a $6.95 transaction cost on a $40,000 trade is .017%. A smaller investor committing $4,000 at the same $6.95 is reducing their return on the trade by .17% on just the initiation side of the transaction. The cost to close out the position will similarly take from the return.
So, the same dollar cost per transaction will impact various size investors differently. The advantage, of course, going to the larger investor. Mathematically that will happen unless the cost per transaction was dropped to $0.00. In October of 2019, the larger online brokerages began eliminating transaction fees on stocks and lowering them on options.
Now, if we do the same math $0.00 on a $40,000 trade versus the same $0.00 on a $4,000 trade, we find the impact as a percent of return is exactly the same. There is no return benefit to the larger order. The only new consideration is investors should be aware that long-term capital gains are treated differently than short-term capital gains. If an investor is inclined to trade more often as a result of zero fees, evaluating any tax consequences should be part of the decision.
To the extent that trading costs have been limiting access or usage by smaller investors, that barrier is no longer an issue.
Accredited Investor Definition
In late December 2019, the SEC voted to propose to amend its definition of an accredited investor. The old SEC rule which determines who can invest in unregistered securities restricts investors based on net worth, income, asset size, governance status, or professional experience. Their reason to seek change to the current rule is to more effectively identify institutional and individual investors that have the knowledge and expertise to participate in private capital markets.
“Modernization of this approach is long overdue. The proposal would add additional means for individuals to qualify to participate in our private capital markets based on established, clear measures of financial sophistication. I also am pleased that the proposal specifically recognizes that certain organizations, such as tribal governments, should not be restricted from participating in our private capital markets.”
- Jay Clayton, Chairman Securities and Exchange Commission
Until there is a proposal that is accepted (currently in comment period until February 17, 2020), an individual accredited investor is one who has a net worth of more than $1 million excluding the value of their primary residence or an income of more than $200,000 annually (or $300,000 combined income with a spouse). This would then mean a non-accredited investor is someone earning less than $200,000 a year (less than $300,000 including a spouse) that also has a total net worth of less than $1 million when their primary residence is excluded. The reason this distinction is important and why one may want to fall under the new definition is it allows them to invest in alternative investment classes such as hedge funds, venture capital, or private equity. Any final change to the guidelines is expected to allow more investors to be considered accredited. It adds new categories of natural persons that may qualify as accredited investors based on their professional knowledge, experience, or certifications. The proposal would also expand the list of entities (not individuals) that may qualify as accredited investors by, among other things, allowing any entity that meets an investments test to qualify.
Small investors have been stuck making decisions in a world where the big investors have access to top-tier company research and industry reports from the largest firms on Wall Street. If you’re too small to be a client of one of these behemoths, you don’t have access. The big investors, especially if an institution, may also have “better” information by hiring staff researchers with advanced MBA or PhD degrees and hard-to come by designations such as CFA or CPA. The small investor obviously can’t financially do this. In addition to staff researchers, larger investors also have had better financial ability to subscribe to third-party research which may have been too expensive for the little guy. Access to quality research could lead to more informed investment decisions by smaller investors.
Instead, until recently, small investors have been relying on resources such as the pundits on CNBC, and publications such as Money magazine. This is quickly changing. The barrier has recently been taken down by third-party research firms allowing all investors access to their analysis and reports at no cost. Recently a few distinguished investment research firms began providing no-cost access to everyone. This new inclusion by way of change in the way these cutting-edge firms conduct business brings down another of the barriers to information that had exclusively benefitted the large accounts.
Small investors have been sold on the idea that they need diversity in their investment accounts. They’ve been told they’re best served if they place their assets in mutual funds so they can spread their risk over a very large array of holdings without incurring large transaction costs and management fees.
There has been a trend in the investment management community that has some Registered Investment Advisors begin to include lower minimums for accounts in their actively managed account offering. These firms are now providing separately managed accounts made up of individual securities holdings (not funds) to people who did not have access before.
Separately Managed Accounts (SMA) are beneficial in that an RIA can take a client’s tax considerations, cash flow needs, risk tolerance, and other financial considerations into the design of the portfolio to create something that performs in a way that better suits the client. With the new low or no transaction costs, and odd-lot trading or allocation provided by today’s technology, prudent diversification could be satisfied in a small account while reaping the other benefits of an SMA.
Access to a professional money manager who can tailor to a small investor’s needs allows the client to speak directly with the person who is responsible for each of their holdings. The ability to refine every aspect of their account cannot be as closely achieved with mutual funds of exchange traded funds (ETF).
As we enter the new decade, investors and investment advisors will have access to a wider array of choices at lower cost with “better” information. This, of course, doesn’t automatically lead to better results. But the potential for fine-tuning portfolios and more confident investing is increasing rapidly.