If Crowdfunding is the New Day Trading, Look Out

In an essay earlier this week on the evolution of money and finance, GigaOM founder and venture capitalist Om Malik argued that crowdfunding will be the new day trading, the latest financial innovation to “cut costs and [drive] wider participation in a previously closed and clubby market.” Advocates of crowdfunding had better hope not.

Paul Volcker famously said the only financial innovation to improve society in recent memory was the ATM. Not everyone agrees. In an essay earlier this week on the evolution of money and finance, GigaOM founder and venture capitalist Om Malik argued that crowdfunding will be the new day trading, the latest financial innovation to “cut costs and [drive] wider participation in a previously closed and clubby market.” Advocates of crowdfunding had better hope not.

To be clear, Malik isn’t talking about Kickstarter where funders make a donation that acts like a pre-order. He’s talking about the public buying stock in private companies, something that may soon be legal thanks to the JOBS Act, and which took a step forward this week with new rules from the SEC allowing private companies to advertise investment opportunities for accredited (read: rich) investors. Now startups and hedge funds alike can advertise the fact that they’re raising money, and some day soon you or I might join wealthier citizens in investing in them.

There’s no doubt that this will drive broader participation in startup investing, but the comparison to day trading confirms crowdfunding skeptics’ greatest fear: that when the party’s over, the public will be left with substantially lighter wallets.

That’s what happened in the case of day trading.

A 2004 study of day traders in Taiwan concluded that, while a small group of traders made money consistently, “more than eight out of ten day traders lose money.” (Subsequent research determined that fewer than 1% of day traders consistently beat the market.) Two of the same researchers found something similar in a broader paper in 2000 on stock trading by U.S. households (not just day trading), which they provocatively titled “Trading is Hazardous to Your Wealth.” Once commission was taken into account, the researchers determined that households did substantially worse than they would have done investing in index funds. Notably, they found that the more households traded, the worse they did:

Our most dramatic empirical evidence is provided by the 20 percent of households that trade most often. With average monthly turnover of in excess of 20 percent, these households turn their common stock portfolios over more than twice annually. The gross returns earned by these high-turnover households are unremarkable, and their net returns are anemic. The net returns lag a value-weighted market index by 46 basis points per month (or 5.5 percent annually). After a reasonable accounting for the fact that the average high-turnover household tilts its common stock investments toward small value stocks with high market risk, the underperformance averages 86 basis points per month (or 10.3 percent annually).

In other words, it’s far from clear that widening participation in the stock market — at least at the level of active trading by individuals — was a good thing.

Malik nods toward this problem, writing of financial innovations:

People race to try it, hoping to earn higher returns, and that works; for a while, anyway. Inevitably, however, the innovation attracts too many newcomers that those returns collapse, leaving huge losses

In the case of day trading, at least, the data suggests lack of knowledge is a more relevant constraint than timing; nonetheless the questions at hand are whether such “innovation” does us much good, and whether equity crowdfunding will be any different.

There are reasons for skepticism: venture capital as an asset class has underperformed the S&P 500 for the last decade, and pouring more capital into VC has historically led to lower returns. Only the top 20% or so of VC firms have a track record of beating the market, and they have the advantage of seeing the best deals (which may never be available to the average crowdfunding investor, at least at comparable terms).

In the case of startups, at least, the time frames involved are long enough that frequent trading is basically impossible. But the central bias the researchers identified as causing individual stock traders to lose money is just as relevant for crowdfunding: “People are overconfident.”

When it comes to the stock market, the deck is firmly stacked against the little guy, and so the best way for most people to invest in it is through a boring old index fund. If investing in startups is anything like picking stocks in that sense, there’s likely to be a dark side to democratization.

Source: HBR blog – Walter Frick
Link: http://blogs.hbr.org/2013/09/if-crowdfunding-is-the-new-day-trading-look-out/

Tags: , , , , ,

HEADLINE NEWS

This RSS feed URL is deprecated, please update. New URLs can be found in the footers at https://news.google.com/news [...]

GizmodoHasbro Is Getting Into Crowdfunding With an Insane Star Wars ToyGizmodoToday, Hasbro unveiled Haslab, which promises to basically be the toymaker's answer to Kickstarter, for diehard fans of its toys. The new crowdsourcing program is kicking off with one hell of a project: [...]

The IndependentFlorida shooting: Crowdfunding page set up for victims' families raises more than $750k in just one dayThe IndependentMourners stand during a candlelight vigil for the victims of Marjory Stoneman Douglas High School shooting in Parkland, Florida on 15 February 2018 [...]

Radio TodayWirral Radio launches a Crowdfunding pageRadio TodayWirral Radio has launched a Crowdfunding page after listener reaction to the closure of the station. Bosses have been holding crisis talks with private investors and businesses after making the announcement last Friday tha [...]

PolygonSystem Shock's massive setback proves everything in crowdfunding is a gamblePolygonNightdive Studios' reimagining of System Shock, which raised more than $1.35 million on Kickstarter against a $900,000 goal, seemed like a sure thing. It had the support of big names in [...]

STLtoday.comSt. Louis Economic Development Partnership launching crowdfunding platformSTLtoday.com“There is definitely a cost to do doing a (securities-based crowdfunding) offering,” Kitzi said. “I don't know if it's prohibitive for everybody, but it is not de minimis.” Stil [...]

ForbesConsidering Crowdfunding? 16 Ways You Can Fight Back Against CopycatsForbesI'm referring, of course, to crowdfunding. What an absolute game-changer. Thanks to the success of sites like Kickstarter and Indiegogo, the crowd can vote with its wallet now. There are enormous ben [...]

Super Bowl Commercials Teach Important Lessons For CrowdfundingForbesCrowdfunding videos are at heart commercials for a campaign. The video that drives a crowdfunding campaign has always been an important part of a campaign. The standard for what makes an acceptable campaign video is [...]

Syfy WireCrowdfunding Creators: Alfred Hitchcock, drag queens, and a lifetime supply of fake bloodSyfy WireWelcome to SYFY WIRE's Crowdfunding Creators, a series that highlights original work by artists looking to make their way in the world on sheer talent and the kindness of st [...]

An introduction to crowdfundingLexologyUnder article 36H of the RAO, loan-based crowdfunding became regulated as the “activity of operating an electronic system in relation to lending". Under this provision, online platforms facilitating loan-based crowdfunding between two indivi [...]

CFB Finance

Marketwired

  • Crowdfunding
  • Crowdfund
  • Peer to Peer Lending
  • FinTech
  • Reg A+
  • Reg CF
  • Crowdfunding USA

Press Release

Live Crowdfunding .tv

What's Next Step in Regulation A+ JOBS ACTS Title IIII :L Interview : Steve Cinelli with Brian Korn Securities and Crowdfunding/Peer-to-Peer Lending Lawyer, Watch more video library | Conference | Interview | Campaign Showcase | Research | Education |