The middle class is often told to start by investing what they’d otherwise spend on a latte. If you put $3 a day aside, you’d have more than $300,000 in 50 years, goes the refrain.
Not many people in the US are listening.
Over a third of Americans spent more on coffee last year than they invested, according to a survey of 3,000 Americans aged 18-44 by Acorns, a California-based company which helps people invest in tiny increments. Getting people without much money to invest small amounts for their own good later on turns out to be much harder than people thought it would be.
If there were any investment product that could solve the problem, it should be the exchange-traded fund. ETFs are inexpensive, modular, and suited for software-based investing because they’re traded easily no matter which financial institution produced the fund and which owns the trading platform. Many of the groundbreaking online firms of the past 10 years have used ETFs, and several, like the online brokerage, Robinhood, have claimed a mission to “democratize our financial system.”
It hasn’t happened.
Stock ownership has become more concentrated among wealthy households. Today, the wealthiest 10% of households own more than 90% of the U.S. stock market, compared with 85% in 1989, according to a January 2019 Goldman Sachs report. For China, Europe, and the US combined, the top 1% wealth share has increased from 28% in 1980 to 33% today, while the bottom 75% share hovered around 10%.
ETFs have contributed to this trend, partly because of how they’re distributed. Back when they were first pushing ETFs, the financial giants made a fateful decision to sell mostly through investment advisors and brokers. That means their ownership is concentrated among upper-middle-class and wealthy households. Of households that own ETFs, 57% have more than $100,000 in income.
Stock market participation is both a sign of rising inequality and a potential solution to it—one of the only ones shown to work. The main mechanisms by which middle- and low-income households can build wealth are home ownership, entrepreneurship, and saving and investing over a long period of time. “To the degree that any wealth is held by households in the bottom half, it’s held either as home equity or retirement savings,” says Ida Radenmacher, vice president of the Aspen Institute and executive director of the Aspen Financial Security Program.
Could ETFs live up to their original promise to democratize investing? The challenges are daunting, including, in many parts of the world, stagnant wages that make it harder for the middle class to invest. However, there are a couple of things that could help, say experts.
Online advisors and mobile apps that change savings habits or attract new investors could yet make a dent. Acorns is a prime example. The company’s app rounds up debit and credit card purchases, investing extra pennies in diversified portfolios of low-cost index ETFs. In 6.2 million accounts, it manages $1.9 billion. (That’s an average of just $306 per account.) Acorns wouldn’t share the demographics of its users, but if a small-increment investing tool catches on among people who otherwise wouldn’t invest that could make a difference, especially if they end up saving for retirement.
Online investing also might play out differently outside the US, broadening stock market participation there. It hasn’t yet made much of an impact in retail investment markets in Asia, according to Leena Dagade, associate director of research firm Cerulli’s Singapore office. “[That’s] due to challenges faced in client acquisition and lack of scale,” she said by email. But there are a handful of companies trying to expand online investing there, including StashAway, Smartly and Bento in Singapore, 8 Securities in Hong Kong, FundsIndia, Stashaway in Malaysia, Raiz Invest in Indonesia and Connect in Thailand.
For online investing to expand savings it will have to overcome a business model challenge. In the new era of investing ushered in by low-cost ETFs, the typical approach of providers is to build high volume, fast—or find other sources of revenue. Last year, it was revealed that US online brokerage, Robinhood, sells its order flow to market makers that are also high-frequency trading firms. Critics called out the practice, which is common but has come under regulatory scrutiny because it can lead to abuses by market makers, as being antithetical to Robinhood’s mission to democratize. The question for Acorns, Robinhood, and their competitors is whether they can reach the scale to be financially sustainable without relying on hidden fees or selling user data.
In the US, policy changes or innovations by companies in the retirement sector could expand access to the markets for low and middle-income workers. “We know workplace retirement plans are only accessed right now by half of the population. We know that were it not for that, there would be more wealth inequality,” says Radenmacher. “It’s a quick jump from the evidence that we should seriously consider every American having access to workplace-based retirement.”
National policy reform is stuck, though a handful of states are experimenting with plans that mandate employers to offer retirement plans. And there haven’t been many innovations in the private sector so far. That could be because ETFs aren’t particularly suited for the retirement sector. One of the few innovators, Guideline, signs people up via employers’ payroll providers, making it easier for small businesses to offer retirement plans. But Guideline doesn’t use ETFs because retirement savers have no need of intraday trading.
And finally, a new strategy known as direct indexing—creating portfolios out of fractional shares of ETFs—offers people with less money a sense of control, points out Daniil Shapiro, associate director of product development at Cerulli. ETFs can allow investing in small increments (many financial companies already offer investors the chance to do that) and investing that’s more fun. You could customize a $100 portfolio from the start, to buy shares of Tesla, SPY and JUST ETF, which tracks companies that rank highly on social justice criteria.
“It’s the Starbucks theory,” he says. In other words, we learned to spend on coffee because Starbucks made it easy and fun, by putting a location on every corner and offering customized choices—eggnog latte, please. But could it happen for saving? Investing has historically not been particularly easy, fun, or widespread. That’s changing, and with the right mix of technology, policy, and innovation, more people might learn to enjoy saving and investing for the long term.