New tools for investing—such as online trading platforms, cryptocurrency, sustainability, private markets, and separately managed accounts with personalised direct indexing—have energised the investing landscape and caught the attention of investors, but how are investors using these tools?
Are they able to use these tools to their full potential and make progress toward their long-term financial goals? Or are investors getting lost in the fray?
According to our research, the answer to these questions is more complex than anyone would like, writes Samantha Lamas, senior behavioural researcher at Morningstar.
Opening doors and opportunities
Research does point to the numerous ways investors are benefiting from new investing tools. For example, online trading tools are dismantling barriers to investing, allowing new and established investors to take a more active interest in their portfolio. Online trading tools are attracting younger investors and more minority investors.
Moreover, some investors are connecting new investing tools to their financial goals. For example, although crypto is a hot topic, more than half of crypto investors report their interest in the asset was spurred by their desire to make good long-term investment decisions, and a third of respondents report using crypto as a diversification tool.
Some investors also recognise that these new tools can help them personalise their investing experience. For example, many high net worth individuals see private capital as an avenue for impact investing (that is, making investments geared toward measurable social/environmental impacts along with financial returns).
Overall, we are just scratching the surface of understanding investor preferences for and interest in these new investment tools and capabilities. And, on the grand scheme of things, given the level of personalisation and customisation they provide, investors’ use of these tools is promising not just for the industry but also for investors themselves.
Some doors do not lead to good places
Now, that was the bright side of the equation, it’s also important to recognise the ways that these new tools can be hurting investors. Some preliminary evidence suggests investors may be engaging with these tools in a way that inhibits progress toward their financial goals due to behavioural biases.
Research suggests that many investors may want to take advantage of new personalisation opportunities but may feel overwhelmed by the decision because of the confusing jargon and a plethora of choices they encounter. The ESG investing landscape is a great example, and our research suggests that investors may be struggling to take advantage of opportunities in this space.
Morningstar research has uncovered a persistent gap regarding ESG investing. The study found 13% of investors reported holding ESG-related investments.
However, another 29% of investors believe company-level ESG policies should be “fairly important” or a “very important” factor in investing despite not having ESG holdings themselves. Although interest in ESG is high, people are not always translating their interest into action.
The ease of use of online trading tools can also facilitate investors making well-known behavioural mistakes. For example, the ease of trading a stock online may be dangerous given previous research, which found individual investors with high trading volume pay a substantial performance penalty.
In our research regarding investors use of online trading tools, we found online investors were twice as likely to trade one or more times a week than online investors, and supporting external research found trading volume generated by individual investors has almost doubled since 2010.
Online accounts also allow more investors access to sophisticated investing vehicles, such as options, leverage, and short-selling.
However, investors may be overconfident about their knowledge of more complex financial instruments. In a study conducted by FINRAii, 62% of option traders were unable to answer a basic question related to options trading and were less likely than investors who did not trade options to admit they didn’t know the answer.
Investors who purchased options were both less informed and more confident—a dangerous combination that can lead to poor risk management. Although investors have always been subject to cognitive biases—such as overconfidence, recency bias, confirmation bias, and regret aversion—online tools have reduced guardrails that may have prevented investors from acting on those biases.
Lower barriers to actions, lower barriers to mistakes
The evolving financial landscape presents investors with a variety of new investing tools, some easy to use with only a few clicks, anywhere anytime.
Collectively, our research on how investors are managing new investing tools calls on the industry to reframe our focus as we introduce these tools to investors. Instead of focusing on the potential capabilities of every new tool, we should focus on how those capabilities can help a person realise their financial goals.
We must also guide investors by veering them away from well-documented behavioural mistakes. For example, nudging them away from excessive trading via reminders of potential tax consequences or emphasising progress toward goals rather than recent short-term market behaviour.
This article was written for International Adviser by Samantha Lamas, senior behavioural researcher at Morningstar.