Why retail investing has taken off in the U.S. - but not Europe

Investors can be divided into two main categories: institutional and

retail

. Institutional investors can be compared to wholesalers who buy wholesale flowers from farmers: they spend money on behalf of their clients and tend to make large-scale investments. It's his full-time job. That's a lot of flowers! Retail investors are more like me: I buy a bouquet of tulips with my own money. Their purchases are smaller and usually require a middleman, such as a florist. Thank you! And just as online flower delivery companies have made it easier to deliver bouquets, platforms like Robinhood have made the markets more accessible than ever.

I heard there were no commission trading and I thought, "Okay, that's great, then I can trade more frequently and not feel bad about it." As a result, trading activity by

retail

investors has skyrocketed. But in Europe, the number of people buying and selling shares is still very low. Many continental European states rely on a mandatory pension system that, frankly, is 100 years old. Therefore, private retail ownership of stock markets would not be promoted in society, right? Basically, Europe is 10 to 20 years away from that culture. So why is this? And with technology changing the way we trade, could European retail investment finally flourish?

To understand why retail investment is not very big in Europe, it helps to look at why it is big in the United States. American households own $38 trillion worth of stocks, either directly or indirectly. That's almost 60% of the entire US stock market. Christian, it's great to finally be able to talk to you face to face, almost. Christian Hecker is the co-founder of Trade Republic, an online broker based in Germany. Why does he think American players have had difficulty establishing a presence in Europe in the past? Well, I think the US market and the European market are structurally very different, especially due to the lack of the 401(k) structure in Europe.

Unlike a traditional pension that guarantees you a certain income in retirement, a 401(k) depends on the contributions you make throughout your career. With a 401(k), you choose your own investments and your account balance fluctuates based on market gains or losses. That means that the responsibility falls on the individual and not on the State. There aren't many types of welfare apparatus in the United States anyway, so it's like you have the responsibility to invest for your retirement. Without 401(k) plans encouraging individuals to invest themselves in the EU, savers have little direct interaction with stock markets. Instead, statutory or state pensions are more common, leaving investment decisions in the hands of governments or large financial institutions.

But there are other factors at play as well. Retail investors may have the perception that access to capital markets is difficult and probably reserved only for the wealthy. Therefore, a change in perception is necessary. Ugo Bassi is a senior official in the financial services unit of the European Commission. The main issue is trust, and the best way to build trust is to set rules that are flexible enough in some ways, but also protect investors and make investors feel protected. Europe has seen retail investor participation double since 2020, but still lags behind other parts of the world. One study estimates that retail activity represents only 5% to 7% of total trade volume in Europe, compared to more than 25% in the United States and more than 60% in China.

Despite this, there are a large number of startups in Europe trying to take advantage of the growing interest. They include Revolut, Trading 212, Freetrade and Trade Republic. These new trading apps typically offer commission-free

investing

and include “gamified” features to encourage engagement as well. I spoke with Eric Liu, an analyst at Vanda Research, who follows US retail activity. We are at a kind of crossroads in Europe. And so he's seen a number of very successful smaller companies trying to do what Robinhood has done here in the U.S. What drove the boom in his opinion? In Europe many people have realized that the state pension system no longer works, right?

And that's why they face a huge gap in pensions and believe that participating in the capital markets is really a source of solving the problem. And that's why we've seen millions of people enter the capital markets for the first time in their lives. So could this be the catalyst Europe has been waiting for? Are we going to see a boom in retail investment? It is a very complex and interesting topic. Digital transformation is undoubtedly a very positive element of the effort we are making to try to bring retail investors closer to the capital markets. On the other hand, of course, it is a phenomenon in general that needs to be kept somewhat under control.

Among the risks of most concern to policymakers and regulators are those associated with “payment for order flow,” something the European Commission plans to ban. Paying for order flow is what makes trading on platforms like Robinhood free. In the past, you couldn't buy stocks through an app. I had to call my broker, who would then call the stock exchange to make the trade for me. The broker charged a hefty fee for the privilege. Now, when you buy stock on one of these new "free" trading services, they send your purchase to another company that makes the transaction actually happen.

This intermediary company, called a “market maker,” needs both buyers and sellers for its business model to work. That's why they pay companies like Robinhood for their trades. Hence the term “payment for order flow”. Payment for order flow has been in the market for a long time. It is used by both big banks and insurance companies and is really the driving force behind the reduction in commissions, allowing especially low-income families to negotiate for a reasonable cost. This model makes trade cheaper. It makes it easy, but regulators argue it's also risky and doesn't take into account the interests of retail traders.

These risks include potential conflicts of interest when a trading platform sends an order to a broker for its own benefit or when a market maker does not offer the best price for a trade. Policymakers have to try to find the right balance between, on the one hand, flexibility and stimulus, and promote all the new tools, instruments and trends, which of course help reduce costs, help people feel more attracted and more interested in

investing

. , but on the other hand we should not underestimate the risks involved and investors should be fully informed about those risks. For many people, financial products and services remain complex.

In fact, "What is the stock market?" is the most visited FAQ page for Robinhood investors. So if Europe bans the order flow payment model, is it possible that a platform like Robinhood exists in Europe? And if not, is retail investment on the continent here to stay? This is a trend that will have no return. It's like social media, once it's opened, Pandora's box is opened and you won't go back. I think they're here to stay, I basically intend to continue, you know, investing all of my discretionary income into the market in some way. In terms of the importance of retail investors over the last year and a half, that's not going to change.

And I think the cat is out of the hat and at this point I think everyone is going to have to follow the retail investors going forward.