Investing Is Simpler than You Think, Part 1: The Rise of Self-Directed Investing

Wednesday, July 24, 2013 at 6am
By John Friedman

I came of financial-career age at E*TRADE in the late 90s. The commercialization of the Internet was in its infancy back then, and so too was the world of online stockbrokers like E*TRADE and Schwab and Ameritrade and Datek (long ago hobbled and then subsumed into Ameritrade).

At the juncture of those two things stood the promise of people investing on their own — of taking-out the middle-man (stockbrokers) and the middle-company distributors for which they worked (Wall Street stockbrokerages) and then replacing the Wall Street stockbrokerages with Internet-only stockbrokerage websites and by replacing the stockbrokers with a promise to yourself that you would do your homework and figure out how to smartly go about, all on your own and all by your lonesome, smartly storing some or a lot of your money in the stock market (yes, that promise is to be double-smart about it).

Before then and going back many decades, Wall Street had erected a veritable wall around itself, through which only the well-to-do could pass (why they chose to erect that wall is a topic for another day). Given commissions in the hundreds of dollars, coupled with restraints on buying any chunk of stock smaller than 100 shares, the normal price of admission for investing in, say, a stock that sold for $50 per share was 100 times $50, or $5,000 (equivalent to, say, $15,000 in today’s dollars), and the commission for buying those 100 shares of stock might have amounted to $250, which is $2.50 for each $50 share, amounting to a 5% commission, which you would also have to pay when you sold the shares, for a total round-trip commission of 10%. Commissions in the 10% range are pretty noticeable when applied to a round-trip in and out of an investment that you hope will provide you with a return of, say, 5 to 10% per year. And by my recollection back then commissions also scaled up along with the size of the purchase, so you paid a bigger commission for buying, say, 200 shares than you did for buying 100 shares.

All together, then, prior to the beginning of the commercialization of the Internet the scale of the dollars involved in investing was off-putting for normal people to say the least: putting together a diversified portfolio of, say, 100-share chunks of ten different $50-per-share stocks would’ve set you a back a cool $50,000 (about $150,000 in today’s dollars), and the transaction cost of a round-trip into and out of those investments would have cost you $5,000 (~$15,000 in today’s dollars). That’s not such a great cherry to put on top, is it?

And then there was the talking on the phone with these broker guys, too, who, back then, were just about entirely of the male persuasion, and who might not have been all that skillful at making you feel comfy and imbuing the whole thing with an aura of being taken care of well and honestly.

So, all in all, the investing marketplace prior to the mid-90s was not a happy place for your average Jack or Jill investor . . . or Pat or Terry for that matter.

*  *  *

The online brokerages changed all that. During the 1990s, Normal Folks — or NFs as I call them — started investing on their own through online brokerages, a practice these days usually referred to as self-directed investing and back then usually called do-it-yourself investing, or DIY investing. This was a huge change: rather than paying hundreds of dollars in commissions for buying or selling a stock, NFs and others using the online houses paid commissions in the tens-of-dollars neighborhood, a much friendlier place indeed (aside for the wonky: remember how back then most online brokerages charged a lower price for market orders than for all other kinds of orders?). And the constraints on buying a small number of shares were also being eased. So, seemingly all of a sudden (though a long time in the making) NFs could buy, say, twenty shares of a stock at fifty bucks each, for $1,000, and pay a commission of, say, $30, which altogether meant that self-directed investing was getting into the range of total doability.

Fast forward to today and you’d be hard pressed to find an online brokerage that charges a commission having two digits to its name, so these days you pay anywhere from $9 and change down to . . . nothing. Yup, commission-free investing is quite readily available today. And please feel free to buy any number of shares you like! One, even.

*  *  *

Back when self-directed investing first started gaining momentum some problems arose — big problems. The biggest problem was that a lot of people who first got into investing in the late 90s got burned very badly when, on March 10, 2000, the Internet bubble burst. Some were burned so badly by that event that they’ve stayed away ever since.

Others got in (or back in, as the case may be) and then got very burned (or very burned again) on September the 15th, 2008 and the weeks after, through March 9, 2009 (yes, early March has been significant in these events!). Both of these big-up-followed-by-big down cycles saw a lot of NFs doubling or even tripling their invested money (yea baby!) but then halving or even thirding it (big friggin’ drat dthat!). And, in spite of ending up in the same place, more or less, guess which of those two things remained most top of mind? That’s right, you guessed it: the losses remained most top of mind because losses loom large a long time, while gains are forgotten quickly.

Those who rode it all out did just fine, thank you very much, and those who first dipped their toes in the self-directed investing waters any time since 3/9/09 have done rather stupendously well. And who knows? Maybe things will be good for a good long while now without the convulsions of bubbles a poppin’.

From here, then, we can look back over first two decades of the commercial Internet and self-directed investing (yup, that’s right: in a few short months all of us will be celebrating the 20th anniversary of the dawning of the commercialization of the Internet, as measured by Mark Andreesen‘s release of Mosaic into the wild on November 11, 1993). And what we see is, first, a full-of-hope infancy, followed by a rather devilish toddlerhood and a fraughtfully pimply adolescence, and now, we may hope, a happily-ensconced, healthily-aspiring, well-adjusted young adulthood.

*  *  *

As went the investing machinery, so too went the investments available within the machinery.

Back in the infancy of self-directed investing it was all about investing in the latest Internet Highflyer, as we called them (indeed, in the E*TRADE Community I hosted back then, our biggest message board went by exactly that name, with as I recall fully two-thirds of our traffic happening there). And that’s from whence a lot of the aforementioned burning and looming-large-losses arose. And then there was also that whole day-trader thing, which was never really about storing money so much as it was about earning a living by getting in and out of investments very rapidly (though nowhere near as rapidly as we do it today).

Some of us, though, preferred to invest a bit more boringly — Investing Slowriders you could call them — choosing to invest in things called Spyders (not the creepy crawlies, and, yes, that spelling is correct) and Diamonds (not the pretty stones) and Qs (yes, that really was what they were and still are called, though some people call them the QQQs, pronounced cue cue cues). Through investments like these and a modest number of other similar investments available at that time, everyone could buy miniscule slices of huge portfolios that mirrored huge chunks of the investment market’s every move, so when “the market” went up 1%, these investments went up 1% and when it went down 1% they went down 1%, just like that, like clockwork and in lockstep (teaser from Part 2: these sorts of investments are called passive index funds).

Today, where once only spiders and gems and difficut-to-use-without-a-U bad Scrabble letters roamed, there now stand hundreds of similar sorts of boring slowrider investments that make it possible to invest, say, $50 in a very well-diversified, very low-cost (i.e., virtually free) fashion. Surely this is a long way and a far cry from the $50,000 investment and $2,500 commission getting-in-the-game ante mentioned above, yes?

So, you might wonder, with the self-directed investing platforms nicely developed at this point, just what sorts of things might you buy with your $50?

That is the topic to which we turn in Part 2.

 

◄ Back to Blog
Categories:
Tags:

Leave a Comment

Name
Email
Website
Message