Beware of turning investing into gambling

Investing these days can be absurdly cheap and easy. But the industry is doing its best to make it expensive, complicated and risky.

Today, you can own the whole stock market at virtually no cost. Fees and commissions have been declining for years. All-in-one ETF portfolios are available at huge discounts to the underperforming mutual funds Canadians were stuck with for decades.

These are changes worth celebrating – but not by the investment industry, which would rather turn you into a day trader. Better yet, a gambler.

An ever-growing roster of exotic exchange-traded funds and the gamification of investing platforms are coaxing regular investors to trade excessively and take on too much risk.

This week, the Ontario Securities Commission published a study warning that trading app features such as the ability to copy the trades of profiled users encourage overexposure and under-diversification.

Judging by the relatively few Canadians taking advantage of the fantastic low-cost options at their fingertips, the industry’s counteroffensive seems to be working.

It’s true, however, that progress has been made. Investors have become much more aware of the corrosive power of fees and commissions.

Since 2013, the industry-average management expense ratio on Canadian mutual funds has declined from 2.06 per cent to 1.47 per cent, on an asset-weighted basis, according to Investor Economics.

Considering there is $2.1-trillion of Canadians’ wealth tied up in mutual funds, this is a great outcome for investors.

But it means the industry is losing out on billions of dollars in forgone fee revenue every year. Bay Street isn’t about to take that lying down.

One way it’s fighting to make up lost ground is through a barrage of niche ETF launches charging premium fees to let investors bet on every conceivable factor, sector, theme and geography.

ETFs were popularized as an antidote to the high-fee active mutual funds that ruled the day. They embraced the idea that you can’t beat the market, so your best option is to track the market at the lowest possible cost.

But most ETFs being spun out today have little in common with the plain vanilla prototype.

There are 23 ETFs in Canada linked to the performance of a single stock such as Nvidia or Tesla. There are ETFs that use leverage to deliver twice the daily returns on Canadian gold miners. Other providers have packaged up hedge fund strategies in an ETF format.

Every year, there are dozens more listed in Canada, the vast majority of them active strategies with premium fees attached. There were 1,027 ETFs trading on the Toronto Stock Exchange as of the end of August, easily outnumbering the total number of TSX-listed stocks.

There has been a similar, ugly evolution in the online brokerage space.

The model initially helped democratize investing for regular Canadians. Online trading platforms gave investors of any means access to financial markets and control over their own savings.

But they have started to resemble gambling apps. It began with Robinhood, the U.S. trading platform that exploded in popularity during the pandemic. Robinhood started to reward its users for trading more frequently and gave the most active users access to riskier options such as margin accounts.

Elements of this gamification have found their way into Canadian trading apps.

Two years ago, the OSC released a report showing that investors who received rewards for buying and selling stocks – like digital points – made almost 40 per cent more trades.

Revisiting the topic in a new report, the regulator identified other emerging features that have the potential to harm investors.

The study featured a trading simulation involving more than 3,500 Canadians who were given $10,000 in pretend money. They were then exposed to various gamification features such as leaderboards, a social feed in which users post about trades, and copy trading, which lets one mimic the trades of a profiled user.

Copy trading, in particular, led to increased risk taking and caused a nearly 20-per-cent increase in the trading of promoted stocks. This backs up other recent studies, the OSC said. It called on regulators to consider limiting the use of techniques that have been shown to negatively affect investor returns.

Jack Bogle, the index investing pioneer and founder of Vanguard, said investors as a group were destined to underperform the market by however much they paid in fees. The more the average investor strays from the market with high-fee strategies, the bigger the performance gap. It’s a lesson that has increasingly resonated with investors worldwide – less so in Canada.

The market share of low-fee passive investment funds in Canada is a measly 16 per cent, according to data compiled by PWL Capital. Outside North America, passive funds have double that market share. Triple in the U.S.

The investment industry today is full of products and applications that encourage Canadian investors to gamble with their savings instead of taking the simple, low-cost approach. Don’t take the bait.