Docstoc

Advantages and Disadvantages of

Document Sample
Advantages and Disadvantages of Powered By Docstoc
					                      Benefits, Costs and Limitations of Online Investing to the Individual Investor




           Benefits, Costs and Limitations of Online
             Investing to the Individual Investor


                                              By

                                  Isaac G. Mathews*




Abstract                                           percentages of total retail trades on
                                                   established      exchanges     like   the
     The Internet has changed the                  NASDAQ and the NYSE, since its
landscape contours of the financial                inception. Just as any application in
services industry in ways never ever               business, online investing has its fair
anticipated. The online approach of                share of not only benefits but also costs
conducting commerce has gained more                and limitations too. The purpose of this
and more acceptance from consumers                 article is to enlighten the reader on the
and suppliers alike. Online Brokerages,            above-mentioned aspects of online
when they first came into the scene,               investing and aid a potential investor to
attacked      mass      markets      with          reflect on these aspects before carrying
unbelievable ease, speed and success               out trades over the Internet.
that it took conventional brokerages
like Merrill Lynch, by surprise. In time,
conventional brokerages having learnt
the advantages of the Internet have                Introduction
moved to create an online presence
for themselves. Online trades are                      The online brokerage phenomenon
accounting for consecutively larger                came into being in the mid „90‟s. Since
 *The author is currently studying for a Masters degree in Counselling Psychology at Assumption
 University of Thailand.




                                               1
Isaac G. Mathews




then it has radically transformed the           not just its       widely    publicized
financial services industry. It gave more       advantages.
weight to the notion of a virtual world
being quite within reach. Investors
could log on from anywhere, at anytime          The benefits enjoyed by an individual
and appreciate market events, and carry         investor due to Online Investing:
out investment decisions over the
Internet. With online brokerages                a) Independence and freedom due to
offering the investor easier and cheaper        access to the markets:
ways of holding trading accounts, the           This is conceivably the greatest
online investment scenario boomed. By           advantage of online brokerages. A
2000, online trades accounted for 25 –          novice investor with an Internet
30% of all retail trades in the US. With        connection can know the real time stock
the American economy in its longest             quotes, historical stock price trends,
expansionary state in the „90‟s, lower          have a handle on market events, access
commission structures when compared             vast amounts of economic and market
to conventional brokerages, online              analysis, do research on firms, and
brokerages saw more trading accounts,           interact with other investors via forums
larger asset sizes managed, and higher          or chat rooms. This, in combination
transaction volumes. Towards the last           with time, can transform even the most
quarter of 2000, the global economy             novice investor with an active interest
was slumping. Investors saw Wall                in investments into a knowledgeable
Street‟s hot picks plummeting and               and powerful investor. (1)
investors grew wary. A passive
portfolio strategy – Buy and Hold, in           b) Elimination of the “middle man”:
other words to wear the Bear out, was           Investing online gives the investor a
gaining more acceptance to those                sense of control over their wealth.
investors that previously sought to ride        Buying and selling of stock no longer
the Bull. With the Internet still               requires another individual to carry it
presenting advantageous avenues for             out. It saves the investor the added
securities trading, investors should also       worries that come with busy phone
realize the costs and the limitations           lines; broker not being in, etc. when
involved while investing online. Like           wanting to do an important trade. It can
with all goods, products and services           be done whenever and wherever by the
that have gained acceptance, online             investor themselves. (1)
investing also provides more benefits
when compared to the risks involved.            c) Elimination of Losses on account
Nevertheless anyone from a student of           of Brokers:
finance to a truly informed and                 Most brokers live on commissions,
intelligent investor should be aware of         hence the tactics used by them are in
the whole landscape of online investing,        the favor of the broker first, the




                                            2
                     Benefits, Costs and Limitations of Online Investing to the Individual Investor




brokerage house next and finally the              now at the fingertips of anyone and
client. Online brokerages pay financial           everyone. Online brokerages are in
advisors a fixed salary, thus eliminating         constant endeavor to bridge the gap
the chance for an investor doing                  between the investor and the market. (5)
unnecessary trades for the benefit of the
brokerage firm and the broker. (2,3)              f) Diverse range of investment
                                                  products and choices:
d) Inexpensive and affordable                     Online brokerages are offering more
commission charges:                               products to the consumer, so as to give
Commissions per trade online are much             the consumer a wider choice and also to
lower than when compared to that                  accommodate consumers that have
charged by traditional brokerage houses           niche tastes. Investors can invest in
like Merrill Lynch, etc. This is the              stocks, bonds, mutual funds, mortgages,
fulcrum on which online brokerages                insurance, derivatives, futures, options,
leverage. Cheap transaction costs along           etc., online through a single or multiple
with the immense amount of                        websites from their home, which was
information accessible online are the             something fictional before the online
biggest reasons for the clients to move           investment phenomenon. (1)
online. Traditional brokerage houses
have brokers that direct clients on               g) Speed of trade execution:
trades. They charge the clients an                Keeping time in mind, online trading is
expertise fee in the form of                      much quicker – as far as accessibility
commissions. This in time and over a              and     availability     to  investment
number of trades turns out to be very             information and execution of trades are
expensive. Online brokerages have                 concerned. Online brokerages have
deleted the broker from the picture thus          decreased the time for total completion
creating a lower commission charge.               of a trade from the regular T+3 days to
Online trades can cost from as little as          a matter of minutes. (2)
$4 - $8 a trade. Active traders at
E*Trade are charged $ 4.95 per trade              h) Security Issues:
from its usual $14.95 per trade                   Given all of the above, clients were
compared to a full service traditional            skeptical to go online simply because
commission of $180 - $250 per trade.              of security reasons. Now, these fears
Amex and Ameritrade offer schemes                 can be rested with encryption
that involve commission free trades. (1,3)        technology at its zenith, the major
                                                  brokerage sites are intrusion tested,
e) Internet as an Information                     with the highest levels of encryption.
Superhighway:                                     Further more all communications
Information related to stocks, company            between the browser and the network,
fundamentals, etc., which were once               occurring in the “secure sockets layer”,
only available to licensed brokers, are           are encrypted. (2,3)




                                              3
Isaac G. Mathews




The costs borne by an Individual                  professionals who would not just
Investor from Online Investing                    recommend a stock without doing their
                                                  due diligence. That's why their services
a) Technical Reliability:                         bear a premium in the form of higher
The greatest disadvantage of online               commissions. A novice online investor
trading is the inability of a network to          with no sound financial basics is more
be fail-safe. Computers in spite of the           likely to invest without proper analysis
technological advances are by no means            of the stock‟s fundamentals like the key
perfect. There are various things that            financial ratios, etc. Online trading sites
could go wrong like failure to log on to          provide investors with vast amount of
the network, network blackout due to              market information without any sort of
power failure, server crash resulting in          personal advice. That‟s where the
site failure, traffic overload thus               bricks and clicks firms have an upper
causing site freeze. Site freeze can              hand. (1,6)
happen on extremely demanding days
with large amounts of orders going over           c) Lack of set of standards for
the networks. This is where Bricks and            service, etc.:
Clicks have an upper hand. Online                 Investors' experience in online trading
brokerages had their share of bad                 differs extensively. It can be from
publicity on October 27, 1997, when               complete gratification to complete
the one-day crash caused trading                  frustration. Sad but true, just like
disruptions at the NYSE (2). People               human brokers and financial advisors,
have gained doing trades online but               online brokerages don‟t have a fixed set
have stood to lose all their profits on           of minimum standards with which
paper by technical faults. Web site               investors      can  benchmark      these
crashes have cost various investors               brokerages and choose the best suited to
substantial sums of money and this in             their liking. (6)
turn has left a bad taste in the investor‟s
mouth. (4)                                        The Limitations of Online Investing
                                                  to an individual investor:
b) The investor is alone:                         Besides advantages and disadvantages,
Another disadvantage may be the                   there exists the possibility of limitations
penalty of a bad investment. The do it            of what online brokerages can do for an
yourself attitude that empowers the               individual investor. Though the Internet
investor over his own money, can give             has allowed more players into the
a sense of autonomy previously not                investment      playing     field,    some
experienced when dealing with                     investors like the institutional investors
traditional brokerages. But it can also           still have an advantage over the
spell investment failure. Stockbrokers            individual investors in spite of the
could     possibly    give     a   bad            Internet and all its advantages. It can be
recommendation, nevertheless they are             assertively said, “Size does matter”.




                                              4
                    Benefits, Costs and Limitations of Online Investing to the Individual Investor




Firstly, because of the sheer size of            restrictions and the costly commission
resources and contacts, institutional            structures placed by conventional
investors almost always get exclusive            brokerage firms. With the online
access to the hottest Initial Public             investment scenario being fiercely
Offering (IPO) deals before it goes into         competitive, such entry barriers could
the markets. Individual investors                never be erected. This has lead more
usually gain access to these stocks after        and more investment savvy individuals
the initial price gain is already lost.          to assume the role of an online investor.
Online brokerages do offer IPO deals –           This may blind a novice investor to the
provided the trading account has                 potential costs involved that may not
between $100,000 to $500,000. Next,              stand out, but nevertheless are as real as
because of their large trading volumes           can be. Furthermore, being armed with
per deal and such trades being done off-         the advantages of online investing, an
exchange, the institutional investors by         individual investor still has to realize
and large execute transactions at prices         that in the face of larger institutional
lower than individual investors. Finally         investors like pension funds, etc. the
because of sheer size and resources –            playing field of investments can never
both financial and human, institutional          be leveled.
investors have the capability to monitor
numerous markets and thus rapidly take                               _____
advantage of any positive market
fluctuations. (5)
                                                                 Bibliography

Conclusion                                       1. Hill, B. (2001). “Why should I
                                                    invest online?” Retrieved on 2002,
     This article centered on the                   March 9.
phenomenon of online investing. From                http://finance.lycos.com/home/perfi
the perspective of an individual                    n/broker.asp?options=why
investor, massively advertised by online
brokerages, investing over the Internet          2. Hill, B. (2001). “Is online investing
provides tangible benefits of ease,                 secure?” Retrieved on 2002, April
control, cost effectiveness, autonomy,              3.
and a diverse product mix of investment             http://finance.lycos.com/home/perfi
vehicles. It is not wrong to                        n/broker.asp?options=privacy
acknowledge the fact that online
investing has opened avenues for                 3. Easton, A., Le Coz, F. (2001).
investors that didn‟t exist before. It is           “Online Investing – Virtual
still a boon to those stock savvy                   Insanity.” Financial Times Business
individuals that never could play the               Limited.     Investors   Chronicle.
markets due to the high entry                       Retrieved on 2001, September 22




                                             5
Isaac G. Mathews




    from Lexis – Nexis database.
    (Academic Universe / Business /
    Business News).
    http://library3.webster.edu:2058/
    universe

4. Goldberg, S. T. (1999). “Online
   Brokers Grow Up”. Retrieved on
   2002, April 5.
   http://www.kiplinger.com/magazine
   /archives/1999/November/ebroker.h
   tm

5. Smith, T. (1996). “The Role of the
   Internet in Finance and Investing.”
   Retrieved on 2002, March 20.
   www.cs.georgetown.edu/~denning/
   cosc450/papers/smith.html

6. Frickle, J. (2000). “E-Trading Is
   Easy     and    Inexpensive    But
   Remember That the Same Rules
   Apply Online”. Retrieved on 2002,
   April 13.
   www.allmerica.com/ww/ww169/pr
   evious/09_00.html
   or
   http://www.vt-world.com/Archive
   /2002/January_9_2002/Features.
   htm

                   ____




                                         6

				
DOCUMENT INFO