Introduction

      Growth of Online Investing

      Reasons for Online Investing

      Challenges Faced By Online Investors

      Resources For Online Investors

      Summary and Conclusions

      References
 
 

    In observing the recent upsurge in online investing Greenwald (1998) commented "it's as voyeuristic as Internet sex sites, more addictive than video games and a lot easier to play--and you can win big money!  It's online investing, one of the hottest destinations in cyberspace."   While Greenwald's conclusion is probably a bit hyperbolic, the level of interest in online investing has increased rather dramatically over the past year.  The objectives of this paper are:  (1)  to review the growth of online investing, (2) to examine the reasons individuals choose to make securities transactions online, (3) to examine some of the challenges individuals who choose to invest online face, and (4) to identify some resources that potential online investors can utilize to avoid the pitfalls of online investing.

       Three years ago online investing was rare.  There were only a few thousand online investors and just three online brokerage firms.  According to Dan Leemon, chief strategist for online trading at Charles Swab, "even a year and a half ago, people in our industry didn't think the Web could compete"  (Brooker, December, 1998).  However, according to Forrester Research, by December 1998,  five million individuals had online accounts.   Forrester Research  projects that by the year 2000 there will be 10.6 million accounts.  The number of online brokers grew from around 50 in March 1998 to about 100 in December 1998 (Carey, 1998).  E*Trade, the second largest online broker, signed up 85,000 new customers in the second quarter of 1998.  At the end of this quarter it had a total of 540,000 online accounts  compared to 20,000 in 1996.  In the third quarter of 1998, Charles Schwab had two million online customers, up from 336,000 in 1996.    Online brokers handle about 253,000 trades per day, making up about 10 percent of all securities  transactions in the U.S.  (Brooker, December, 1998).  International Data Corporation  estimates that online brokers earned $1.28 billion in revenues from online trading in 1998, and that they will earn $5 billion by the year 2002 (Woods, 1998).

   From the above, it seems reasonable to conclude that online investing has caught on and is definitely  in a growth mode.
 

    Julio Gomez of Gomez Advisors, a research firm in Concord Mass., indicates that the primary reasons for the upsurge in online trading are:  (1)  the lower commissions of online brokerage firms as compared to full-service brokerage firms, and (2) the convenience of online trading made possible by the improvement in computer technology (Brooker, 1998).  Over the past two years, commissions for online trading dropped 70 percent from an average of $53 per trade to $16 per trade.  By comparison full-service brokerage firms charge from between $300 and $500 per trade (Brooker, 1998).  Gomez's conclusions are largely supported by the survey results of the American Association of Individual Investors (AAII).  In a survey of its members who invest online, conducted in December, 1998, AAII  (On-Line Discount Broker Survey Results, 1998) found the primary reasons for online trading were as follows:
 

     The AAII survey results indicate that nearly 50 percent of of online investors choose their online broker on the basis of the commissions charged by the broker.  Twenty-three percent of the investors select the online broker on the basis of the services offered by the broker, and 16 percent make their selection on the basis of the convenience (ease of use) of the online broker.
 
 

Caveat:  Internet Fraud

    In October, 1998, the Securities and Exchange Commission (SEC) conducted a country-wide operation to deal with internet stock fraud.  This operation resulted in the filings of 23 enforcement actions against 44 companies and individuals (Stock Fraud Reached Out On The Net, 1998).  John Reed Stark, special counsel for Internet projects at the SEC's Division of Enforcement indicates that the growth of online investing has created, as a byproduct, another growth industry, namely an industry of "crooks and thieves" looking to defraud unsuspecting online investors.  He points out that the perpetrators of such fraud can easily and with little expense create a legitimate looking web page to attract unsophisticated and unsuspecting online investors.  One type of perpetrator, referred to as a "Spammer" can get a list of users from an investor newsgroup and then send them "news" about some bogus investment opportunity.  So with very little expense, the perpetrator is able to reach a large number of potential victims.  Another technique employed by the perpetrators of internet fraud is to intercept the email messages of public companies, alter the contents of the messages for their own purposes, and then  forward them on.  This technique is used in stock price manipulation schemes.  For example, suppose the CEO sends a message to potential investors or shareholders indicating that next quarter's earnings are going to be better than expected.  Of course, such news would tend to increase the price of the company's stock.  The scam artist who intercepts the message may alter it to indicate that the earnings are going to be worse than expected.  When this news gets out, the price of the stock tends to fall, and the perpetrator buys the stock.  But later, when the truth becomes known,  the price will rise and the perpetrator sells the stock for a profit (Stock Fraud Reached Out On The Net, 1998)

    Of particular concern to the SEC are fraudulent schemes operating outside the U.S. Such schemes are very difficult to prosecute in the U.S. (Fuller, 1997).

   Katrina Brooker (October, 1998) provides some real life cases of internet fraud.  In one case an individual, whose day job was running an escort service, created a web site offering information about "a high tech startup company."  While all of the information regarding the company was bogus, this individual attracted 100,000 investors to the legitimate looking  site.  Three thousand investors from around the world emailed the perpetrator for more information, and 150 actually sent checks.  Altogether the perpetrator took in $190,000 with the scheme.

   None of the internet scams are really new.  However, because of the low cost and ease of use of the internet, such scams are much easier to carry out.  As Brooker (October, 1998) notes "now, instead of having to go out and find their victims, cyberscamsters can sit back and let investors come to them."

    How does the individual online investor protect herself/himself against internet fraud?   The best place to start  is to always remember the (pre-internet)  phrase "let the buyer beware."  NASD Regulation, Inc., the securities regulatory organizations,  ( Possibilities and Pitfalls, August, 1996) provides extensive advice on how the online investor can prevent  being victimized by online perpetrators of fraud, and how to seek redress if victimized.
 
 

Getting Prepared for Online Investing

    Online investing  made possible by the development of the internet and advances in computer technology has made the purchase and sale of securities much less costly and more convenient for the individual investor.  However, it is important to understand that the use of online investing is merely a tool to more efficiently implement an overall investment strategy.  If the individual is to achieve her (his) investment goals, development of an investment strategy must necessarily precede the actual buying and selling of securities, regardless of  whether these transactions are made using an online broker or a full service broker.  An individual's investment strategy must be based on factors such as the individual's  investment goals,  risk tolerance level, and  time horizon (Mayo, 1997).   Identifying resources that  the online investor can access to develop an investment strategy will be considered in the next section of the paper.

    Once the online investor has developed an investment strategy, using online investing to execute the strategy is more convenient and less expensive than using a full service broker.  Assuming that  the investor has developed an investment strategy and has chosen to invest online without the services of a full service broker, (s)he is ready to begin  the online investment process. In order to effectively and efficiently utilize an online broker the individual investor should be aware of some important  aspects of  online investing.  These include:  (1) selecting the appropriate online broker, (2) determining the computer technology requirements for effectively investing online, (3) becoming familiar with the procedures and requirements of the online broker selected, and (4) remembering that online trading is merely a tool to implement an investment strategy (Gallo, December, 1998).

    Currently there are  about 100 different  online brokers.  The types of services available vary considerably among these brokers.  Some are more suited for experienced investors who don't need much investment advice.  Others offer a wide range of research and educational materials.  Also, the range of securities that the individual can buy or sell varies.  Some brokers offer a full range of securities. Others  provide a  more limited range of securities.  The online investor should do some research to find an online broker that most closely meets her/his needs.  There are resources available on the internet to evaluate online brokers.  Gomez Advisors (http://www.gomezadvisors.com/Finance/Brokers/Scorecard) rates online brokers on a range of factors such as ease of use, on-site resources, customer confidence, and cost.   The American Association of Individual Investors (http://www.aaii.com/ ) provides periodic reviews of investment web sites, including online brokers.

   In the process of selecting an online broker, the potential online investor must evaluate the computer technology that is needed to invest online with the different online brokers.  The potential online investor should determine if her/his modem has enough speed to carry out transactions in a timely manner.  In addition, (s)he must determine if her/his operating system is current enough to execute the online transactions.  For example, most online brokers require the use of java. (Gallo, December, 1998).

    Once the online investor selects a broker, (s)he should become familiar with the rules and terms of trading securities.  Failure to do so can result in higher transactions costs (Gallo, December, 1998). Most online brokers facilitate "practice trading" before trading for real.  The online investor should practice before beginning to execute real transactions.  According to online trading experts, many online investors fail to practice before doing real trading.  The result often times is that they spent so much time executing a trade that the price of the security they are buying or selling changes (in some cases dramatically) before they complete the transaction  (Gallo, December, 1998).

    Once the  investor becomes familiar with online investing, it becomes easy and results in savings for the investor.  However, it is important for the online investor not to become infatuated with the process, and to remember that it is merely a tool to achieve her/his investment goals.  It is important to remember this since with online trading it is easy to make transactions.  Unless the investor has a clear investment plan, online investing tends to cause the investor to engage in too many transactions (Gallo, December, 1998).
 
 

    When the individual investor chooses an online broker rather than a full service broker to make securities transactions, (s)he is to a large degree choosing to become her/his own investment advisor.  There are many  resources available on the internet that the online investor can utilize to become a more knowledgeable investor. The purpose of this section is to provide an overview of some of these resources.

     Many novice investors begin by investing in a mutual fund.  Mutual funds provide the benefits of diversification and professional management.  The Vanguard Group ( http://www.vanguard.com/ )  and T. Rowe Price ( http://www.troweprice.com/ ) are no-load  mutual fund groups that provide excellent educational materials on a wide range of investment topics.  In addition both sites allow  individual investors to track their portfolios online.  The sites are well organized and presented in such a way so as not to overwhelm the beginning investor.  Access to these sites are free.

    The American Association of Individual Investors'  (AAII) site ( http://www.aaii.com/ ) is probably the most complete educational site for the individual investor.  The site contains:  (1)  an educational program for the individual investor on all aspects of investing, (2) an extensive tools section that allows the investor to engage in stock screening and portfolio analysis, (3) online access to past issues of the association's journal,  (4) a search capability of the archive of the association's journal, and (5) a guide to investment web sites.  Since AAII is a not-for-profit organization, it does not endorse  specific products.  Access to some parts of AAII's site are free.  However, certain parts of the site are limited to members.  Membership cost is $49 per year.

   There are a very large number of additional sites that provide resources for the online investor.  Reviewing all of these sites is beyond the scope of this paper.  A good place to begin reviewing some of these sites is by examining the AAII's guide to investment sites.  Another site, Invest-o-rama ( http://www.investorama.com/ ) contains links to more than 8,000 financial sites grouped into 13 categories and 75 subgroups.  Ultimately each individual must choose those sites that best serve her/his particular needs.
 
 

   There has been a dramatic growth in online investing over the past three years.  This growth is attributable primarily to the convenience and cost savings associated with online investing as compared to investing with a full service broker.  There are some challenges faced by the online investor.  The online investor must recognize that online investing is merely a tool to execute an overall investment strategy.  In order to achieve her/his investment goals, the online investor must  take steps to prevent becoming a victim of internet fraud, and  become familiar with the intricacies of online investing.  This paper has identified some online resources that  the  investor can utilize to become a more knowledgeable investor.

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Brooker, Katrina.  (1998, December 21).  Online Investing:  It's Not Just For Geeks Anymore.  Fortune, 89-97.

Carey, Theresa W.  (1998, December 21).  Curiouser and Curiouser. Barron's Online.  [On-line].  Available: http://interactive.wsj.com/archive.

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Greenwald, John.  (1998, May 11).  A Nation of Stock Keepers:  Online Trading Is Quick, Cheap, and Growing Fast.  Time, 48-50.

Mayo, Herbert B.  (1997).  Investments:  An Introduction.  (5th ed.).  New York:  The Dryden Press.

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Woods, Bob.  (1998, November 11).  Full-Service Brokerages Face Online Challenges-Study. Technology Internet Updates.  [On-line].  Available:  http://www.skali.com.my/technology/iup.