By Karen Petrou
There is an extensive literature on the “unbanked.” But what of those one might call the “unsecured?” In previous blog posts, we have pondered “equality banking” and “equality insurance.” Now, we turn to equality investing, doing so not just because savings at ultra-low interest rates has become the road to ruin, but also because several retail brokers have redesigned entry-level investing with considerable equality upside. Although caution is always warranted when products are aimed at inexperienced investors, “fractional share” options and no-commission fees could make a meaningful difference for millennial and lower-income households hoping to have enough put aside over time to own a home, ensure a secure retirement, and protect their families from the unexpected.
The Importance of Having Equities
Ideally, entry-level wealth accumulation should come in the form of principal-protected savings. Conventional financial advice thus tells young people as they enter the workforce to save a small amount, diversify into stock-market investments over time, and then to watch their nest eggs grow. As 401(k) plans proliferated, this old-school construct has expanded also to include employer-matched investing. This has opened financial markets to many employees, but millions remain outside the reach of these accounts or are unable to reserve enough from their paychecks to make contributions large enough to matter over the long-term.
Passive investment funds such as the Vanguard S&P 500 are another way into the market, but the most popular of these funds requires a $3,000 investment, an insurmountable threshold for many younger and lower-income households. Average millennial net worth is just $8,000.
Even so, low-and-moderate income young Americans are determined savers. They thus continue to follow old-school advice and put a little bit into a bank account whenever they can. Lower-income savings rates are actually astounding. The retirement-savings crisis isn’t because Americans are profligate; it’s because ultra-low rates set them back no matter how hard they try.
A stylized example I recently used in a speech makes it painfully clear why thrift doesn’t pay. From 2007 to 2019, the S&P index for stocks rose 77 percent – that is, an investor with $10,000 in the market at the start of the crisis would have $17,700 to show for it by 2019. Starting also in 2007, $10,000 in a bank deposit earning the usual compounded interest rate of 0.50 percent would have only $10,615 or a six percent return to show for it after twelve years. Add in a two percent inflation rate – again about right given the high costs of post-crisis consumption – and our thrifty saver has only $8,522 – i.e., in real terms, a loss of fourteen percent.
The Equality-Investing Equation
Clearly, a way needs to be found for small savers to diversify so that they are also small investors. Fractional-share purchases – in which an investor buys a percentage of an equity investment, not the whole share – is one way to make this possible. Although fractional-share purchases have been possible for some time, the October 17 announcement from the Charles Schwab brokerage company brings fractional stock buying into the mainstream market.
A few examples show how fractional shares make an equality difference. Buying one share in Amazon as of November 8 cost $1,785.00 and one for Alphabet (Google) was $1,309.00. Buying into Warren Buffett’s Berkshire Hathaway cost $331,899.99 for a single share. One of course could have bought Ascena Retail Group for $0.40, but that isn’t exactly what a broker is likely to recommend with an eye on principal protection and long-term appreciation.
Clearly, a diversified portfolio of high-quality stocks is a virtual impossibility when one share eats up twenty percent or more of an investor’s net worth, but this diversified, high-quality portfolio is an equality essential as long as interest rates are ultra-low. A 10% Amazon share costing only $178.50 or a similar Alphabet purchase of $130.90 is affordable. Berkshire-Hathaway would need to be a 1% purchase if it could be managed at all, but many high-quality shares are within millennial reach at fractions of their full price.
Fractional shares are, though, no wealth engine if commissions take away too much return. These have long been another equality barrier to entry-level investing. First, they cut into the value of an investment, especially a fractional one, by eroding the principal value of an investment. Commissions also create broker incentives that, if not carefully controlled, run counter to equality investing. When brokers are compensated on commissions, brokers have an all-too-human incentive to “churn” an investor’s portfolio – that is, to persuade the investor to buy and sell stocks in ways that generate commissions for the broker at little or even no benefit to the investor. Small, relationship-focused fees far better align broker and investor interests.
Equality investing took a leap forward not only as fractional shares became available, but also as commissions quickly disappeared at many retail brokers after October 7, when Schwab abolished commissions and created a competitive whirlwind that blew them away at most of the other large retail companies over the next few weeks.
Millennial investors without a parent or trusted adviser to guide the way need model portfolios assembled of fractional shares acquired without commissions. In a sense, these are mini mutual funds, actively assembled by a brokerage firm, 401(k) plan, or other provider to capture the ease and cost essentials and convert them into a long-term winning portfolio.
In 2016, the average 32 year old millennial has 41% less net worth than those the same age enjoyed in 1989. Retirement savings have thus become a national crisis, as legislation yet again pending in Congress bears witness. Even so, the Financial Times took a swipe at Schwab’s assertion that fractional shares enhance generational equality. Instead, it suggests that “redistribution of wealth for young Americans” is the way to go. The FT doesn’t make clear if it here means a guaranteed income, a wealth tax that takes from the rich to give to the poor, or some other way to build a better bootstrap. Its discretion may well be due to how hard it is not only to craft any of these redistributional alternatives, but also to persuade voters to back them.
Fractional shares, no-commission brokerage, and better advice won’t make America egalitarian all over again. However, equality-investing does help small savers also to become little-bitty investors. That’s at least a chance for a bit better a bit sooner.