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The retail investing landscape has been changed forever in the wake of both Covid-19 and the emergence of zero-commission online brokerage firms. According to JMP Securities data, the US brokerage industry added around 10 million new clients in 2020 alone, with an estimated 6 million gravitating towards the market leader, Robinhood. However, Robinhood may have found itself to be a victim of its own success as the investment market continues to swell and more rival firms from the world of fintech battle for customers.
With this in mind, how can online brokerages improve their business models to win customers and continue to build on the industry’s recent growth? Let’s take a look at how 2022 will be a pivotal year for the retail investing landscape.
The Challenges Brought by Success
Whilst there’s little doubting that the Covid-19 pandemic created the environment that drove significant growth in retail investing. But we can actually trace the moment that sparked the industry’s growth back to late 2019 and the widespread adoption of payment-for-order-flow brokerage models.
(Image: Nasdaq)
As we can see from the chart above, the shift to zero-commission, PFOF models was followed by a period of rapid growth that predated the emergence of the pandemic.
Payment-for-order-flow allows brokerages to market themselves as zero-commission, although their revenue comes from making deals to sell their order flow to the marketmakers that handle the orders of customers.
In this arrangement, although the customers aren’t paying commission on top of the cost of the stocks they buy, the marketmaker leveraging the purchase of stocks is free to charge different rates to make a trade happen.
(Image: The Economist)
Above, we can see how scattered the market has become as order flow gets distributed across the industry’s major players.
Although Robinhood has performed exceptionally well in the wake of the transition towards payment-for-order-flow, the platform has struggled in the wake of going public in mid-2021 – with shares in the Nasdaq-listed HOOD down some 34% at the time of writing.
Robinhood has been on the receiving end of some criticism throughout the year from major Wall Street stalwarts like Warren Buffett and Charlie Munger, who have likened the platform to a ‘casino’. Other critics have pointed out that Robinhood has deployed gamification tactics to encourage more active trading among investors on the app.
Such criticisms show that the rapidly growing industry surrounding retail investors still has plenty to learn, and as the growth of fintech continues to produce more firms offering investment tools, 2022 may prove to be a pivotal year for brokerages.
Let’s explore how online retail brokerages can improve their business models in 2022 to create a thriving and safe investing environment for their customers:
Education, Education, Education
We may be seeing far greater volumes of retail investors arriving on the market, but it appears that their intentions have been scattered and largely unfocused in the months that followed the arrival of the pandemic.
(Image: Financial Times)
Throughout 2020 and 2021, retail trading themes have heavily featured meme stocks as well as ESG, ETFs, growth, and travel stock investing – showing that investors appear to be bouncing from asset to asset-based on sentiment online.
Recently, the FCA warned that younger investors have been taking on significant risks with their stock purchases, with as much as 59% claiming that a significant investment loss would carry a fundamental impact on their current or future lifestyle. Furthermore, 38% of young investors surveyed were unable to provide a single functional reason for investing in their top three stocks.
This means that it’s essential for online brokerages to prove more educational tools for their new pool of investors.
Whilst this may be a feature that some brokerages are reluctant to implement – after all, the more likely investors are to trade stocks repeatedly, the more money they will make through order flow – it’s an essential tool for earning the trust of investors. This could help to secure more custom over the long term, rather than risk being perceived as exploiting your customers by keeping them in the dark.
Revamping Client Acquisition
“The biggest challenge for new online brokers is the competition in the industry, as discount brokers, mutual fund companies and other specialist providers have already captured 25% of the retail market with lower commissions and more entrepreneurial use of technology,” warns Maxim Manturov, head of investment advice at Freedom Finance Europe. Moreover, these firms are poised to further capture a significant market share. Thus, the challenge for new brokerages will be to compete adequately with the already dominant platforms.”
“To attract more retail investors, new brokerage firms should improve their client acquisition processes, lower the minimum investment threshold required to open an account and make their platforms as simple, intuitive and easy to use as possible, as well as expand deposit methods,” Manturov added.
In order to compete adequately in an ever-growing market, Manturov believes that brokerages should reconsider factors like minimum investment thresholds whilst simplifying their platform user interfaces.
This represents a vital step that brokerages can make in adapting their product for the range of newcomers entering the market. The arrival of new retail investors should be regarded as a victory for investment inclusivity across a landscape that’s often been dominated by institutional investors.
Simplifying your product for new users, or introducing a ‘pro’ and ‘lite’ version of your platform depending on the experience levels of investors – much like what can be seen with cryptocurrency investment platform, Binance – can help brokerages to better accommodate users and win their trust.
By doing this, they can not only generate greater volumes of custom but also help to build investor confidence at the start of what’s set to be a growing trend of investors adopting brokerage apps to make their first purchases in the market.
