Innovations and Challenges

New tools for investing—such as online trading platforms, cryptocurrency, sustainability, private markets, and separately managed accounts with personalized direct indexing—have energized the investing landscape, garnering interest from both the technology and finance industries. With this new excitement, however, many may have failed to consider how investors are managing this onslaught of
new investing tools and to what degree these new capabilities promote investor success. In other words, we need to understand the relationship between investors, their long-term financial goals, and new investing tools.

In our research, we find the evolving investing landscape simultaneously presents advantages and pitfalls to investors. Although investors benefit from the expansion of investing opportunities and accessibility, they also struggle with old and new behavioral challenges sometimes exacerbated by new technology. It is worth remembering that investing tools are a means to an end. And, with any new
extension and increased capacity of technology, there is still a human being grappling with how to use available means to achieve their goals.

Key Takeaways

• Investor goals have remained fairly consistent in that building a safe and secure retirement, owning a home, paying for children’s  education, and building both lifestyle and legacy have remained priorities. Investors are motivated by these powerful, long-term goals; however, goals are often neglected when touting the strengths of new tools.
• The potential of new tools is palpable, and we are just scratching the surface of understanding investor preferences for and interest in these new investment tools and capabilities. On the other hand, some preliminary evidence suggests investors may be engaging with these tools in a way that inhibits progress toward their financial goals due to poor choices driven by familiar pitfalls.
• Collectively, our research on how investors are managing new investing tools calls on the industry to reframe our focus as we introduce these tools to investors. Instead of focusing on the potential capabilities of every new tool, we should focus on how those capabilities can help a person realise their financial goals.

The tools for investing are evolving quickly; investors are not

The investing landscape is rapidly changing. Retail investors are presented with a growing number of assets available to them, like cryptocurrency and private equity, along with new opportunities to manage their holdings, like direct indexing and online trading platforms. Some of these developments are well-known to the public given their starring role in viral moments, such as online trading platforms and cryptocurrency, but retail investors must also grapple with less-viral developments to investing that are part of the shifting landscape. For example, Fidelity, Schwab, and Morningstar have launched direct-indexing solutions with far lower minimum investments than previously required for direct-indexing services (just $5,000 in the case of Fidelity), opening the door for greater portfolio personalisation and tax management to many investors. Relatedly, the proliferation of ESG investing has allowed investors to align their investments with their values and to evaluate the risks of their investments with a broader lens. Finally, retail investors have increasing access to private markets, through both the new possibility of including private equity in 401(k) plans in the U.S. and increasing access to relevant data and opportunities.

Investor goals endure

The technology and financial industries have poured significant resources into developing these new tools, but tools do not exist for their own benefit. Tools should help people achieve a goal they have in mind. Fortunately, the financial industry has little to do by way of guessing what goals investors care about, given there is plentiful research on the topic. By and large, investors have the same goals as ever:
to build a safe and secure retirement; to own their own home; to pay for children’s education; and to build both lifestyle and legacy.

Additional research has uncovered other goals that crop up alongside these main goals, such as giving to charitable organisations, consistently funding leisure interests, and engaging in hobbies more meaningfully. Overall, the picture that emerges from this collection of
research is that people see investing as a means to fund their future lives, both how they live them and the kind of legacy they leave behind.
Investors are motivated by these powerful, long-term goals; however, goals are often neglected when touting the strengths of new tools. Although financial professionals may see a connection between the benefits of new tools and investors’ goals, it is unclear if individual investors see the same connections—which brings about the question, how are investors engaging with these new tools? Moreover, are they reaping the benefits of these new investing opportunities and connecting them back to their goals? Or are they struggling with both new and old behavioral challenges, amplified by the speed, power, and complexity of new innovations?

Investors are benefiting from the evolving investing landscape

New tools are opening doors

Some preliminary evidence suggests investors are engaging with innovations in ways that help them move toward their financial goals. For example, auto-enrollment in employee retirement plans has dramatically increased the number of participants, with a Vanguard study reporting an increase in enrollment of 63% in their own 401(k) program. Additionally, online trading platforms have provided a
lower barrier of entry for potential investors and allow them to take a more active interest in their portfolio. Morningstar research found online trading platforms are also bringing investing to different people than more traditional avenues, attracting younger investors and more minority investors. Additionally, investors who use trading platforms were more likely to trade a variety of assets than investors who do not use trading platforms—not just stocks (91% vs. 63%) but also ETFs (52% vs. 36%), crypto (70% vs. 24%), and options (26% vs. 17%). This suggests online trading platforms engage new investors and encourage them to explore a variety of asset classes and strategies.

Some investors do have long-term goals in mind

Subsets of investors are connecting new investing tools to their financial goals. For example, although crypto is a hot topic, more than half of crypto investors report their interest in the asset was spurred by their desire to make good long-term investment decisions, and a third of respondents report using crypto as a diversification tool.9 Additionally, some investors are using online trading platforms for more than
the short term; 18.6% of online investors reported investing money they expected to need in the next five years, and 37.2% reported investing money they expected to need within the next 10 years or later. These findings suggest there is a sizable subset of investors who recognise these new tools can help them invest for their future goals.

New tools make greater personalisation possible

A growing number of investors also recognise new tools can help them use their money in ways that align with their values. For example, many high-net-worth individuals see private capital as an avenue for impact investing (that is, making investments geared toward measurable social/environmental impacts along with financial returns).11 Retail investors are also interested in the opportunity to have
their investments reflect their values. A Morningstar study investigated whether investors would incorporate ESG information into their investment decisions during times of an intense market downturn and found that investors were willing to invest more money in funds with better ESG scores, even during weeks of whipsaw volatility.12 This tendency reflects broader trends in the industry and an increased interest in ESG investing, with recent research putting the number of investors interested in ESG investing at about 70%.

We are just scratching the surface of understanding investor preferences for and interest in these new investment tools and capabilities. Investors’ use of these tools is promising not just for an industry betting on them but also for investors themselves. Recent years have shown the power of personalisation on people’s behaviors. People may be attracted to portfolio personalisation not only because they have grown accustomed to such treatment in other domains but also if they can see how personalisation helps them achieve their goals—especially since personalized goals are associated with better goal adherence and goal-striving behavior.

As such, investors can create a financial plan that fits with their values, interests, and goals, which may also help them persevere and stay the course over the long haul.

However, investors are falling into familiar pitfalls in new ways

On the other hand, some preliminary evidence suggests investors may be engaging with these tools in a way that inhibits progress toward their financial goals due to poor choices driven by familiar pitfalls. For example, although investor knowledge gaps have always existed,15 they may now impede investors from realizing the value of new investing tools. Furthermore, some tools may increase investors’ vulnerability to decision-making biases,16 making it easier for financial mistakes to be made.

Investor knowledge gaps get in the way

Direct indexing is becoming widely available thanks to new technology. Though direct indexing offers advantages, a study from Morningstar17 found investor knowledge gaps may prevent some investors from recognizing all that direct indexing and portfolio personalisation have to offer. In the study, investors rank ordered benefits of portfolio personalisation based on their perceived importance.

On average, investors gave top rankings to items such as “Achieving my financial goals” and “Tailored to my personal circumstances” but gave tepid rankings to offerings related to ESG, reducing fees, and tax management. This finding is concerning for fee and tax management, as investors may be failing to recognise the enormous impact these two items can have on reaching their financial goals. In other words, it’s not that these features aren’t important; it might be that investors may fail to connect these offerings to their goals and, thus, undervalue them. Therefore, investors may benefit from guidance on how new tools serve their enduring goals.

Shining a spotlight on our biases

Choice overload, preferences, and action

ESG data offers a relatively new lens for investors to evaluate and understand more about risk and impact. Yet, ESG is not for everyone. Plenty of investors shun the idea of ESG and ESG ratings and dislike when such information is made available to them.18 Still, some investors want to inform their investment choices with ESG data but struggle to turn motivation into action. Morningstar research19 has uncovered a persistent gap regarding ESG investing. The study found 13% of investors reported holding ESG-related investments. However, another 29% of investors believe company-level ESG policies should be “fairly important” or a “very important” factor in investing despite not having ESG holdings themselves. Although interest in ESG is high, people are not always translating their interest into action. A possible explanation20 for this gap is investors are facing choice overload, which cannot be solved by more data. Rather, investors need help understanding what available data means for them and how to translate their preferences into high-quality portfolios.

Lower barriers to actions, lower barriers to mistakes

Online trading tools have made investing more accessible than ever, leading to a recent uptick of new investors. More people benefiting from the power of investing is a good thing; however, online trading tools can also facilitate investors making well-known mistakes. For example, the ease of trading a stock online may be dangerous given previous research, which found individual investors with high trading
volume pay a substantial performance penalty. Morningstar research found online investors were twice as likely to trade one or more times a week than non-online investors,23 and supporting external research found trading volume generated by individual investors has almost doubled since 2010.

Additionally, investors report motivations for making a trade that points to the role of behavioral biases in their financial decisions. For example, 48% of online investors25 showed signs of returns-chasing, a common consequence of recency bias (that is, the tendency to overweight recent events), reporting they made a trade because they thought it would “make me a lot of money.” Investors’ financial decisions may also be getting derailed by herding behavior (like the tendency to follow whatever the crowd is doing); 19% of online investors mentioned making a trade because “lots of people were talking about it” versus only 6% of non-online investors.26 In a separate study, 44% of “meme” stock investors reported “they didn’t want to miss out on the action”—a clear sign of regret aversion (that is, the fear of missing out by not acting even when the wisest move is to stay put and do nothing). All these biases swirl together to form a perfect storm when fanned by media and online forums and facilitated by apps that reward speculation over sound evaluation. As a result, investors get ensnared in well-known decision biases that usurp prudent judgment.

Online accounts also allow more investors access to sophisticated investing vehicles, such as options, leverage, and short-selling. However, investors may be overconfident about their knowledge of more complex financial instruments. In a study conducted by FINRA,  62% of option traders were unable to answer a basic question related to options trading and were less likely than investors who did not trade options to admit they didn’t know the answer. Investors who purchased options were both less informed and more confident—a dangerous combination that can lead to poor risk management. Sophisticated investing innovations are just tools, and in the right hands, they can be powerful components in an investment strategy; in the wrong hands, these tools provide painful examples of the Dunning–Kruger effect, where people do not know what they do not know, yet presumptuously plunge ahead with bad consequences.

Although investors have always been subject to cognitive biases—such as overconfidence, recency bias, confirmation bias, and regret aversion—online tools have reduced guardrails that may have prevented investors from acting on those biases. Based on investor behavior and motivations in online tools, many investors need help managing their biases and these new tools make that more challenging.

Conclusion

Collectively, our research on how investors are managing new investing tools calls on the industry to reframe our focus as we introduce these tools to investors. Instead of focusing on the potential capabilities of every new tool, we should focus on how those capabilities can help a person realise their financial goals. We must also guide investors by veering them away from well-documented behavioral
mistakes. For example, nudging them away from excessive trading via reminders of potential tax consequences28 or emphasizing progress toward goals rather than recent short-term market behavior.

The evolving financial landscape presents investors with a variety of new investing tools, some easy to use with only a few clicks, anywhere anytime. However, as these new tools/means are developed, it is worth remembering that investors need help connecting their choices today with their goals/ends. Though there are clear benefits new tools can provide (diversification, tax management, low fees, transparency), the evolving landscape can exacerbate well-known behavioral pitfalls as well. The connections between investment capabilities and investor goals need to be illuminated and reinforced by independent voices that value investor success over fomenting frenzy and exploiting foibles.