Humans are meaning-making machines.
We see patterns where there are none; create inferences where there are only associations and distil intent where there is only coincidence. Making meaning is why we have both religion and science: two different fruits of the same tree. A tree we managed to climb down from to create the complex and interconnected world we live in today.
Investing and finance are as built on myth as any other part of human life. Money is a myth. We choose to exchange goods and services for pieces of paper, and these days, bits and bytes moving from my account to yours. Money has no intrinsic value beyond what we assigned it. That doesn’t make it any less useful. It makes our complex lives possible; and it is under-pinned by a state who only accepts legal tender in exchange for our annual tax obligations. But at its heart, it is still a myth we have all agreed to believe in because it makes our lives easier.
How is this relevant to retail investing? Because when we look at these trends, there are underlying stories that keep recurring.
Let’s start with a benign example, like exchange-traded funds and the broader rise of passive investing.
At its most stringent and theoretical, passive investing is the rational response to a belief in the efficient market hypothesis. ‘If markets are efficient, all information is already in the price, and so expected alpha in the market is zero.’ Although you don’t have to go this far to prefer passive. You may believe alpha is possible, that there are inefficiencies, but predicting which asset manager will outperform is difficult, and therefore passive makes more sense. Or you could believe the costs of alpha make it untenable.
These might be why some professional investors favour passive - but is it what draws retail investors?
Maybe. However, there is also a powerful narrative behind passive and ETF trends. A narrative about the trustworthiness of financial intermediaries, about disillusionment with the financial establishment, and a belief that while doing it oneself may not be best, it may be the only option left in a world of financial crookery.
We see these stories amplified in the zanier developments of recent financial alternatives. In the GameStop debacle, it was easy for professional investors to snigger from the side lines about gullible retail investors wasting their life savings, saying that retail investors don’t understand markets or pricing or the role of hedge funds, or many other financial ‘tenets’ - but I’d argue there was something deeper going on.
Behind the headlines was a story about the struggle of Main Street versus Wall Street. Of the disconnection between wealthy financiers and retirees that can’t make ends meet. Of the chasm between those who have and have more – and those who always seem to be losing.
It’s easy to underestimate the power of stories. It may seem ridiculous to professional investors to stake one’s life savings based on a Robin Hood narrative. But people have died for narratives, all through history. Stories about family; nation, religion, ideology. Human life is built on narratives.
Another example is BitCoin and its crypto-cousins. Commentators have been pointing out pitfalls in the cryptocurrency world for a while, and yet now states’ central banks are considering digital currencies. Even the all-serious periodical, The Economist, has dedicated an insert to these developments.
BitCoin has a powerful anarchic, anti-authoritarian narrative underpinning it. Plus, highly aspirational narratives. Of women being able to earn incomes in countries which disallow it. Of people in poor countries, with uncertain economic regimes, gaining a foundation on which to build.
Does this mean you should invest in BitCoin?
Compelling as the stories are, they can be a deceptive basis for building wealth. Believing the current financial system has deep problems doesn’t entail that BitCoin specifically will correct them. Yet that belief can propel people into an investment that feels more like a “vote” for change than a dry investment choice.
Whether BitCoin becomes an incumbent currency will be affected by factors beyond the narrative propelling it. If it becomes more mainstream, it may even lose its value in that narrative.
This recurring narrative baked into retail investing trends has a life beyond any specific investment and its implications for the financial system are not yet clear. Although institutional investing drowns retail investing out, there are trends in motion that could threaten this world as well. The boomers are retiring, withdrawing their funds from the market, COVID upended the world of work, and employee benefits are being renegotiated. What happens if workers would rather be remote and flexible than have a company pension? And what happens if employers decide they quite like that idea as well?
When we get down to it, stories affect many investing questions. Which industry we believe has the best prospects. Which companies we believe are the best run. Which investment philosophy we favour.
Professional and retail investors alike are trading on stories.
These stories say more about meta-trends than about the success or failure of a specific investment choice. Following these stories may not lead to your best investment, but they could clue you into where the system is going. Which is why these stories matter. If people are willing to invest money into a story, then it’s a story we need to heed.