Oppression of India’s Investment Landscape: Why Investor Protection Must Come First

India’s investment landscape is undergoing a seismic shift. Technology, innovation and new distribution models have democratized access to capital markets, making investing easier and more accessible to retail investors. With over 170 million demat accounts by August 2024 and rapid growth in AUM of domestic mutual funds driven by factors such as SIP (Systematic Investment Plan), steady investment in the range of Rs 20,000 to 25,000 crore monthly, has driven the retailization of India’s financial markets. For a strong generation of investors eager to participate.

However, this increased reach is accompanied by a worrying trend: investment tyranny, which has increased the risks for the average investor. It is time to have an honest debate about the reforms needed to ensure that financial innovation continues to serve the interests of investors without compromising their protection.

The boom in technology with smartphones available as low as INR 7,000-8,000 and the rise of fintech platforms to some of the cheapest smartphones in the world has brought retail investors to the fore in India’s financial markets. While this democratization has many benefits, it also fosters the “gamification” of investing – where investment apps resemble video games more than serious financial instruments.

With elements such as rewards, badges, leaderboards and frequent notifications, many platforms are designed to encourage frequent trading and high-risk investments without the necessary disclosures for investors to fully understand the implications of their investment choices. In short, many of these trading platforms do not provide adequate investor education or warning about potential downsides.

Even some of India’s major trading platforms are not exempt from this. While their intuitive and easy-to-use platforms enable investment decisions for a new class of retail investors, the user interface is often designed to encourage activity. Data from the Securities and Exchange Board of India (SEBI) shows that 93% of retail traders incur losses when it comes to derivatives.

This gamification is part of a larger trend of retailization, where financial products traditionally accessible only to sophisticated investors are now marketed directly to retail participants. From small-cap stocks to options trading and speculative investments in crypto assets, retail investors are now gaining access to complex financial instruments without adequate risk assessment or education.

Over the past several years, Indian markets have performed well and the outperformance in small stocks is more pronounced. This may have created the impression that higher risk means better returns, enticing retail investors to be more aggressive in their portfolio decisions.

The downside of gamification is that it often plays on cognitive biases—investors’ tendency toward overconfidence, fear of missing out (FOMO), and impulsive decision-making. Research shows that frequent trading is rarely in the best interest of retail investors. According to a 2021 study conducted by CFA Institute, high-frequency retail traders underperformed by an average of 4-5% annually, due to poor decision-making, high transaction costs and taxes.

In addition, the influence of social media and so-called “fininfluencers” increases the risks. It is possible that like many other markets. Many new retail investors in India are influenced in their investment decisions by social media stock tips without fully understanding the fundamentals of what they are investing in. This leads to herd behavior, forcing investors to chase trends instead of making informed, long-term decisions. . It has the potential to destabilize the market in the long run and erode investor confidence.

To address these challenges, the regulatory environment should consider evolving to ensure investor protection in the era of gamified trading and social media influence.

Here are the main changes that should be implemented:

Enhanced disclosure requirements and risk warnings: Some of these are already in place such as risk disclosures on derivatives which highlight a SEBI study that 9 out of 10 individual traders in the equity futures and options segment, net losses and loss makers in excess of net trading losses, report net trading as transaction costs. Cost an additional 28% of damage.

However, there is room for improvement and investment platforms should adopt transparent disclosure practices that clearly communicate the risks associated with frequent trading and complex products. Similar to health warnings on cigarette packs, trading platforms should present prominent risk warnings before investors can access high-risk products. Additionally, they should offer standardized performance tracking tools that show investors their net return after fees and taxes.

Regulation of investment gamification practices: The Securities and Exchange Board of India (SEBI) may consider issuing guidelines on gamification elements used in trading applications. Gamified features such as rewards, streaks, and leaderboards encourage excessive trading regardless of risk and are in direct conflict with the principle of prudent investing. Similar to recent regulations implemented in other markets such as the United States and the EU, SEBI may also impose a “cooling-off” period to introduce friction and allow investors to review their trading decisions.

Recognition and Regulation of Financial Influencers: “Fininfluencers” who use social media to provide investment advice should come under SEBI’s regulatory purview. Their proposed framework seeks to ensure that individuals influencing financial decisions on social media and other digital platforms are either registered or fully accredited.

It aims to amend existing rules to prohibit any tie-up between SEBI-regulated entities, such as stockbrokers or asset managers, and unregistered financiers.

The proposed changes would prevent regulatory entities from engaging in promotion, advertising or referral-based partnerships with non-registered individuals. In addition, SEBI-registered financiers will be required to display their registration details, contact information and adhere to a strict code of conduct in all their financial materials.

Investor Education and Literacy Initiative: The increase in retail participation highlights the urgent need for a national strategy to improve financial literacy. While technology has made investing easier, it has also made it more complicated and risky, making it easier for retail investors to lose money. SEBI, in partnership with financial institutions and educational institutions, should give priority to comprehensive educational programmes.

It focuses on the fundamentals of investing, financial planning and the dangers of over trading. A 2022 survey by the National Center for Financial Education found that only 27% of Indians are financially literate – a figure that should be improved to ensure investors can make informed decisions. There is a greater need to make investors more aware of the nuances of their investment choices.

India stands at a critical moment in its financial history. While the rise of retail investors and the tyranny of investing represent exciting opportunities, they come with inherent risks that require careful management and a strategic, pragmatic approach. The proposed changes, focusing on transparency, regulation of gamified practices, fininfluencer accreditation and investor education, are not only necessary—they are urgent. The goal is to balance innovation with investor protection by ensuring that increased participation in capital markets contributes to a stable, sustainable and equitable financial future for India.

By taking proactive steps to curb gamification and support investor protection, India can continue to build a vibrant retail investment ecosystem that serves both individuals and the broader economy. In the words of Warren Buffett, “The risk comes from not knowing what you’re doing.” Let’s make sure our retail investors know exactly what they’re doing with their hard-earned money and savings.

(The author is Pankaj Sharma, Senior Manager, Capital Markets Policy, CFA Institute. Views are his own)

(Disclaimer: Recommendations, suggestions, opinions and views given by experts are their own. These do not represent the views of Economic Times)