App-etite for Destruction

Very few derive more satisfaction from seeing the little guy stick it to Wall Street more than yours truly. As those closest to me can attest, I have my own longstanding beefs with Wall Street, and it starts with its historical exploitation of average investors. Wall Street’s good ole boys club has been notorious for reaping billions at the expense of average investors. So, imagine my delight when, in the wake of the meteoric rise in GameStop shares at the hands of the little guys, Wall Street suddenly began crying foul, demanding SEC and/or Justice Department investigations and intervention. Suddenly, Wall Street was FOR regulation. How humorous. 

To be fair, however, not all Wall Street funds were caught in a “short squeeze” (when those whom have sold a stock short, believing the price would go down, are forced to buy back those shares to cover their positions when the tide turns against them, that is, prices rise). There were numerous Wall Street firms whom, alongside individual investors, reaped substantive gains on the rise of GameStop shares, thanks to long positions. Particularly, Senvest Management LLC, reaped a jaw-dropping $700 million-dollar-payday on GameStop shares, perhaps more than all the individual investors combined. But let us not allow facts to get in the way of the delight we felt at Wall Street’s suffering.

Humor aside, the GameStop escapade highlights the burgeoning popularity of trading by individual investors, utilizing trading apps like Robinhood which tend to gamify investing. It is not difficult to fathom how such gamification could become hugely disastrous. We need look no further than the young man who committed suicide this past summer, influenced by the mistaken belief that he had reaped substantial losses—to the tune of over $700,000—while trading complex options. Certainly, not every single case of loss, real or perceived, will be as dramatic, but the need for caution is still necessary and urgent. 

Robinhood, in its defense, has resorted to threadbare retorts, casting aside all legitimate criticisms as “elitist” attacks while reasserting itself as an avenue for average investors to reap the market gains that, hitherto, has been the alleged exclusive domain of Wall Street. Yet, Robinhood failed to disclose to those very same average investors that it was being highly compensated for its order-flow (a process by which trading firms pay millions of dollars to brokerage firms for directing trades its way). One cannot, both, claim to be a proponent for the “little guy” and, simultaneously, intentionally withhold material information from the “little guy” that might affect his/her decision-making. In its efforts to deflect criticism, Robinhood has even leveled attacks at the principled Charlie Munger, Warren Buffett’s right-hand man and vice chairman of Berkshire Hathaway.

Beyond withholding information regarding its payment for order-flow, it is quite disingenuous for any trading app to encourage a culture of day/options trading by unsuspecting, unsophisticated individuals while also claiming to be their friend (and by “unsophisticated” I simply mean someone not trained, academically or by experience, in investment finance). As the proverbial saying goes, with friends like Robinhood who needs enemies. To be clear, these are not investing instruments…but are, for the unsophisticated average investor, weapons of near-mass destruction. It is no different than urging your childhood friend to go down to the local casino every day and oh, by the way, advising him/her to take out a loan from the casino while he/she is there. I am not sure about you, but I would never encourage my friend to engage in such foolishness. Yes, my friend might post a big win here-and-there but, over the long term, he is bound to lose his shirt…and his tie. The odds will never be in his favor. Gambling is never an investment strategy.

What is an investment strategy for the average investor is a long-term investment in a broad index fund that tracks, for example, the S&P 500 Index (i.e., “the market”). The secular trend of the market has always trended up. Sure, there will be short-term fluctuations, mostly as a result of the short-sightedness of the market. Long term, however, the market will offer the average investor an annual return in the neighborhood of 7.5-8.0%, a historical fact dating back to 1957 when the S&P Composite Index expanded to 500 from 90 stocks. Going back even further, the historical return average gets better. Index funds are cheap to boot. For example, Vanguard’s average expense ration is just 0.07%!

And can anyone guess what constituency would be the biggest beneficiary of a long-term average return hovering around 8%? You guessed it: younger investors with a long-term investment horizon, a constituency on whom Robinhood thrives. This is because, with a longer investment horizon, investors are better able to withstand the short-term vicissitudes of the market, thereby smoothening out its return performance. Then there is the magic of compounding. Again, with a longer investment horizon, younger investors are better able to maximize their returns over a longer period. A no-brainer.

Which brings us to our conclusion.

Clearly, I am of the opinion that index funds are a much, much better option for average investors, for the reasons outlined above and more. If, however, the rise and influence of trading apps is here to stay, I would issue a little bit of advice to the likes of Robinhood. For starters, if Robinhood and the like is truly on the side of the average investors, it would encourage its loyal followers to do more long-term index investing with the majority of its investing dollars. Of course, you will still have those who want to gamble or roll the dice, and that is fine…as long it comprises no more than 5-10% of a portfolio. 

Next, if Robinhood is serious about its mission, it would disallow the practice of trading in options and eliminate margin accounts for average investors. There should be a certification process in place, much like Interactive Brokers, to determine if an individual has the requisite background knowledge and/or experience—and financial means—to engage in options or margin trading. 

Finally, I am all about average investors making money…nothing gets me more excited. However, I believe it should be done in a smart, sensible way. Indeed, we can stick it to Wall Street without gambling and, as Peter Lynch would say, beat the street.