Private investment

Playing with money

Whether shares, ETFs or cryptocurrencies: During the corona pandemic, young people have flocked to investing. Will this lead to a rude awakening - or a secure pension?

A colorful illustration of a young person in a baseball cap lying comfortably on the floor, holding a smartphone in his right hand and a disproportionately large piggy bank in his left. Robin Hood rises from the smartphone like a genie in a bottle. Dollar, euro and bitcoin symbols float around the illustration.

The "Robin Hood" app is a prominent example of a free trading platform. It was developed in the USA

Stock markets are indicators of both the economy and the collective behaviour of a society. Health crises are also reflected in the stock markets. But never before have the global financial markets been as jolted by a health crisis as with the corona pandemic. This is partly because the coronavirus spread faster than other viruses, and partly because of the tough measures taken around the world: from distance and hygiene rules to far-reaching travel restrictions and lockdowns.

But while prices dropped precipitously at times in 2020, trading volume on the stock markets actually grew of late. One of the reasons is the young people, in particular, who entered the stock market during the Corona crisis. This seems to be not only a direct consequence of the lockdown boredom, but also related to the multitude of free trading apps that appeared during this time. These promise to make private investing easily accessible, interactive and as exciting as a computer game. A prominent example of such a free trading platform is the app “Robinhood”, developed in the USA, whose use is associated with minimal hurdles. A bank account, a minimum age of 18 and a smartphone: that's all it takes to get started. There are no commissions, even though Robinhood earns money through premium services. 

Elsewhere other trading apps have also been developed, for example “Wealthsimple” in Canada, “Futa” and “Tiger Brokers” in China or “Freetrade” in the UK. With a swipe, smartphone owners can access the stock market at any time and any place - and during the pandemic, of course, especially from home. Moreover, because users can not only invest in individual shares and in ETF index funds via the apps, but can also trade in trendy products such as cryptocurrencies or more complicated derivatives such as options.

“Concern is spreading among the public in the face of reports about the reckless investment style of some young investors. In June 2020, Alex Kearns, a University of Nebraska student, took his own life after his Robinhood account showed a loss of $730,000”

Among young adults, this caused a boom: most Robinhood users actually opened their accounts during the Corona crisis. They were spurred on by discussions in the social media and by the comments of prominent investors such as Tesla boss Elon Musk, who were not afraid to tweet about investment opportunities such as cryptocurrencies and co. Even on the online platform Reddit you can now find a wealth of investment tips. 

But trading platforms and apps like Robinhood are controversial. While financial experts see the advantage of young adults participating more in the stock market, regulators are rather sceptical about the new investment tools. It is not for nothing that the Financial Conduct Authority, the British financial regulator, recently warned of the high risks that young investors take in their investments.

And public concern is also spreading in the face of reports about the reckless investment style of some young investors. In June 2020, Alex Kearns, a University of Nebraska student, took his own life after his Robinhood account showed a loss of US $730,000. Shortly before his suicide, Kearns accused Robinhood's operators of putting him at too much risk. However, it later emerged that Kearns may have simply misunderstood Robinhood's financial overview, according to a family member. A tragedy that underscores how risky complicated financial instruments can be - especially in the hands of new investors.

Yet the question of how dangerous the stock market is always depends on how one invests. Clever and far-sighted investors like the US entrepreneur and major investor Warren Buffet, after careful analysis, invest in companies they consider undervalued on the stock market. Newcomers and young investors, on the other hand, often make their decisions on the basis of irrelevant information or “market noise”, a tendency that has earned them the name “noise traders”. Overconfident investors are often under the illusion that they can beat the market with a little talent or a lucky hand. In fact, most “active” trading strategies are far less profitable than market index funds that do nothing more than track market performance. Especially in times when anyone can get into trading from home, it is important to keep this in mind. 

In any case, historical data on the performance of equities suggests that holding a few well-diversified index funds or ETFs (short for exchange-traded funds) over the long term is a much easier and more rewarding strategy for retail investors than active trading. The reason: the long investment period makes the daily fluctuations of the stock market insignificant and the cumulative return greater. A well-known rule of thumb therefore says that you can determine the percentage of your portfolio that you should put into shares with the simple calculation “100 minus your age”. Younger people should accordingly put more money into shares, as they can hold them longer. Patience is therefore the key to investment success.

“In fact, scientific knowledge often plays a smaller role for investors in the stock market than their risk and self-assessment - and this not infrequently also depends on cultural and geographic factors”

But scientific findings actually often play a smaller role for investors in the stock market than their risk and self-assessment - and this not infrequently also depends on cultural and geographical factors. In a cross-national study, finance scholars Mardy Chiah and Angel Zhong found that trading volume in the corona pandemic increased especially in markets with greater speculative opportunities. So it seems that investing money is currently a substitute for gambling to some extent in some places. Moreover, according to studies, investors from individualistic cultures are more prone to overconfidence and brisk trading than others. 

And how cautious or patient investors are also depends not only on their age, but on their cultural background. Comparative studies have shown, for example, that students from Nordic and German-speaking countries are among the most risk-averse and patient investors. This can sometimes have an ambivalent effect on their willingness to invest: Either these people are too risk-averse to invest in the stock market at all, or their patience gives them a better return on investments in the long run once they have invested their money.

According to surveys, people from East Asian countries are also more patient when it comes to investing money. The financial risk of investing can also be cushioned by larger social networks and family safety nets. This could explain why gambling is very popular in East Asia. In the stock market, however, the combination of a relatively strong risk appetite and a long-term orientation can be a good foundation. These people are brave enough to enter the market and at the same time willing to stay long enough to reap the corresponding returns.

In addition to cultural norms, technological developments also influence investment behaviour. As already mentioned, smart investors should hold diversified stocks for a longer period of time. However, Robinhood and similar social trading platforms are a double-edged sword from this point of view: on the one hand, they make the stock market more accessible to young adults. The average age of Robinhood users is not 31 for nothing. On the other hand, these platforms are not structured to encourage passive and long-term investments. Already, initial analyses of app traders' behaviour show that they tend to be less responsible and often trade far more aggressively than the average investor. Moreover, Robinhood investors seem to be increasingly inclined to take risky bets on crisis-ridden companies.

“Is it possible to teach young investors about the potential of equity investing while making a clear distinction between investing and gambling?”

So the important question for the future is not whether the stock market is too dangerous for young people in general, but: Is it possible to teach young investors about the potential of equity investments while making a clear distinction between investing and gambling? And the answer to that is: yes. Because young investors can learn about risk and not only when they take risks. Instead of having direct experience with bad and reckless investments, education should enable them to deal with terms like “risk”, “return” and “investment horizon” from an early age.

After all, having solid financial literacy would not only help young investors develop a sensible and responsible investment culture, but it would also lead them to channel their resources into the most productive and sustainable sectors of the economy. So instead of keeping the next generation away from the stock market, it is much more important to promote a responsible approach to the stock market and investment. 

Not least because investments in equity securities will continue to be an important instrument of financial investment and provision in the future. In his book “Stocks for the Long Run”, the American finance professor Jeremy Siegel showed that one US dollar invested in stocks in 1801 would have become a proud 12.7 million US dollars in 2001. The lesson: an investment in the stock market has been far more lucrative than any other form of investment over the past 200 years. If one had invested in gold for one US dollar in 1801, this gold would have been worth only 32 dollars in 2001. 

More and more people are now realising that it pays off to start early. When Moira O'Neill, the editor of the magazine “Moneywise”, once asked her readers over the age of fifty what they wish they had known in their twenties, one of the most remarkable answers was: “I wish I had looked at a long-term chart of the stock market, because then I would have started investing at a young age.” When one of the magazine's authors then actually showed her twelve-year-old daughter the chart of the long-term investment comparison in Siegel's book, the girl immediately decided to invest her excess pocket money in exchange-traded funds.

If we could include such long-term charts and the associated economic knowledge in school textbooks, it would be a boon for our society.