The Importance of Courting the Individual Investor.(some 48% of American households own stock, as the individual investor becomes more important in corporate financing plans)

Publication: Business Horizons

Publication Date: 01-JAN-01

Bookmark this article Print this article Link to this article Email this article Digg It! Add to del.icio.us RSS

COPYRIGHT 2001 JAI Press, Inc.

Savvy companies know that attracting "the little guy" is a real boon to stock price stability. But the investment mix has to be just right.

Up until about 35 years ago, Wall Street treated individual investors as royalty and lavished much attention on them. However, beginning in the mid-to-late 1960s, the role of the individual investor began to wane as, over the course of the next three decades, institutional investors--mutual funds, banks, insurance companies, pension funds, hedge funds, and other entities that invest other people's money--came to dominate trading volume. Concurrent with this rise in trading volume, institutional investors fully captured the attention and adulation of Wall Street and, more germane to the current study, the companies whose stock traded on the major exchanges.

In effect, the individual investor was relegated to the status of a second-class citizen. With the exception of the scattered dividend reinvestment programs and isolated direct stock-purchase programs being initiated, marketing efforts focusing on individual investors were largely nonexistent. Conventional wisdom held by many chief financial officers of publicly traded companies was that: (1) there were too few individual investors, (2) what funds they had to invest were too small to matter, and (3) when they did invest, they ignored individual stocks, preferring to invest in professionally managed mutual funds instead.

In what can be considered a major yet largely overlooked trend, the number of people investing in the stock market is growing at a significant rate. Even though most of their investments are still being made through institutions (50.2 percent of corporate equities are held by institutions, 41.3 percent are held by individuals and nonprofits, and 8.5 percent are held by foreign investors), the potential exists for companies to capture more of these funds on a direct basis. As of 1999, more than 48 percent of U.S. households owned stock, representing a 71 percent increase over 1989. Of this total, more than 51 million individuals owned stocks of individual companies (as opposed to owning shares of mutual funds). According to Federal Reserve numbers, U.S. households have increased their stock holdings from 14 percent of financial assets in 1982 to 34 percent in 1998, while stocks as a share of total assets have jumped from 15 to 24 percent.

Why the rise in the number of individual investors? First, the bull market that began in 1990 has provided, on average, double-digit returns on investments. In 1999 alone, stocks comprising the S&P 500 Index had an aggregate return of 21 percent. Compared to the mid-single digit yields available on most certificates of deposit, stock investment represents a risk well worth taking to a growing portion of the populace. Second, over the course of the past decade, corporate America has steadily migrated from offering employees traditionally defined benefit pension plans toward offering defined contribution plans, such as 401(k)s or supplemental retirement accounts (SRAs). This gives the individual much more control and latitude in making investment decisions. In fact, some argue that the 401(k) plan may be the single most important factor in the rise of the individual investor, for it has forced people to learn about the stock market, allowed them to watch their assets grow, and made them realize what the market can do for them.

Third, the Internet has greatly leveled the playing field between individual investors and professional money managers. Individuals are researching and trading stocks over the Net, with information they could not have dreamed of acquiring even a few years ago. Analyst reports, detailed earnings forecasts, chat room discussions, investment commentary, and instantaneous news retrieval are just some of the investment tools readily available at a steadily decreasing price. Further, largely because of the advent of the Net, the cost of trading has dropped to a very affordable level, while the ease of trading could not be greater, with individuals only a mouse click or two away from buying and selling stocks. In sum, big growth potential, the freedom to control one's investment destiny, a growing sophistication about markets, an explosion of accessible information, and fingertip technology have all combined to entice more and more individuals to enter and remain in the stock market.

The profile of the "typical" individual investor is changing as well. It is no longer the stereotype of an older, affluent, white, college-educated man. More than half of today's investors are under 50 years old and only half are college graduates. Women, who now comprise about 47 percent of investors, are more conservative, which may contribute to a more stable market as the size of their investments grows. More important, most investors are using the stock market to realize long-term gains, not a short-term windfall. (Although some may mimic the actions of day traders, the vast majority of individual investors are long-term.) Only about 20 percent of all investors have ever taken "a big financial risk" to realize a major gain. Moreover, 89 percent plan to use their stock investments for retirement; only a small portion of them also plan to use the investments for a major expense, such as buying a new car, purchasing a home, or financing children's college educations.

The growth in the...

Read the full article for free courtesy of your local library.