Retail Investor: A Blessing or a Curse?

Retail investors are often described as a positive force.

They bring more money into capital markets. They help companies raise capital. They make investing less exclusive. They reduce the dependence of businesses on banks and large financial institutions.

All of this is true.

But there is another side to the story.

A large group of people entered financial markets without learning how those markets work. Technology made investing simple, but it did not make investments simple. Today, a person can open an account, transfer money and invest in a complex financial product within a few minutes.

This is progress. It is also a risk.

In practical terms, a retail investor is a private person investing their own money. They are not managing capital for a bank, investment fund, pension fund, insurance company or another institution.

The US Securities and Exchange Commission describes retail investors as individuals who invest their own money for personal goals, such as retirement, education or buying a home. (SEC: https://www.sec.gov/newsroom/speeches-statements/mjw-speech-032114-protecting-retail-investor)

In the European Union, the definition is more legal.

Under MiFID II, a retail client is simply a client who is not classified as a professional client. A client can be either a natural person or a legal entity. (EUR-Lex: https://eur-lex.europa.eu/legal-content/EN-BG/TXT/?uri=CELEX%3A32014L0065)

This creates an important distinction:

In normal language, a retail investor is usually a private individual. Under EU regulation, a retail client is any client who has not been classified as professional. In the United States, an accredited investor is a separate category based on wealth, income or professional knowledge. (SEC: https://www.sec.gov/resources-small-businesses/capital-raising-building-blocks/accredited-investors)

This means that retail should not be defined only by the size of the investment. A large portfolio does not automatically mean professional knowledge.

Private investors have existed for as long as public capital markets.

Individuals were already buying shares in banks, railways, factories and trading companies in the eighteenth and nineteenth centuries.

However, the modern mass retail investor did not appear at one specific moment. The market developed in several waves.

During the late nineteenth and early twentieth centuries, shares slowly became available to people outside the wealthiest families.

But access was still difficult.

Investors had to use traditional brokers. Trading commissions were high. Information moved slowly. Building a diversified portfolio required significant capital.

Direct ownership of shares therefore remained limited.

Investing was technically open to the public, but it was still not designed for the public.

Mass retail investing began to grow more seriously with the development of investment funds during the twentieth century.

Funds solved one of the main problems for small investors.

Instead of buying shares in many different companies, a person could buy one unit in a diversified fund.

After the Second World War, retail investing expanded together with:

In the United States, pension accounts and mutual funds gradually turned investing from an activity for wealthy families into a normal part of middle-class financial planning.

The next major change came between the 1970s and the 1990s.

Discount brokers reduced trading costs. Later, the internet allowed individuals to:

The interface is liquid. The asset is not.

By the late 1990s, online brokers were already making trading significantly cheaper and easier.

The basic structure of investing did not change. Distribution changed.

The investor no longer needed a personal broker. The investor only needed an internet connection.

After 2000, several new tools made investing even easier:

This was another major step in the democratisation of finance. It also changed investor behaviour. The distance between seeing an idea and investing money almost disappeared.

A person could read a post, download an app and buy an asset on the same day.

The COVID-19 pandemic accelerated the trend.

People spent more time online. Some households accumulated additional savings. Markets fell sharply and then recovered. Mobile platforms made registration easy. Interest in shares, options, cryptocurrencies, crowdfunding and meme stocks increased.

In France alone, around 800,000 new retail investors started investing in shares between 2020 and 2022. Research also found that many new investors were younger, digitally confident and not fully aware of investment risks and costs. (OECD: https://www.oecd.org/content/dam/oecd/en/publications/reports/2023/10/new-retail-investors-in-france_9aecd005/2cd2565d-en.pdf)

The retail investor did not appear in 2020. What appeared was a younger, faster and more digital version of the retail investor.

The history of retail investing is not only the history of growing wealth. It is the history of falling barriers.

In the past, investing required significant capital. Today, a person can invest €10 or €100.

In the past, commissions were high. Today, they may be very low or even presented as zero.

In the past, information came through brokers and newspapers. Today, prices, opinions and analysis are available in real time.

In the past, opening an investment account required paperwork, phone calls and physical meetings. Today, onboarding can take a few minutes.

The modern retail investor is therefore not simply a “small investor”. It is a private owner of capital with direct technological access to financial products that were previously distributed by banks and professional intermediaries.

That is where P2P enters the story.

Peer-to-peer lending brought a new group of people into investing. Many of them believed they were buying something similar to a bank deposit with a higher interest rate.

In reality, they were buying credit risk.

Depending on the platform and legal structure, they could be buying:

These products may look almost identical on a screen.

A person transfers €1,000 and sees an expected return of 10-15%. But legally, that person may own very different things.

They may have:

Most retail investors cannot answer the most basic question: Who exactly owes me the money?

That is the first serious problem.

P2P did not create financial illiteracy. It exposed it.

It gave an unprepared retail audience access not only to public shares, but to products combining several risks at the same time:

These are risks normally analysed by credit committees, lawyers, compliance teams and risk managers.

But in P2P, they were often presented through a simple interface with a large interest rate, a short risk description and an “Invest” button.

The industry made access simple. It did not make the underlying risk simple.

One of the clearest examples is the European investor compensation framework. Many retail investors have heard that investments are protected up to €20,000. But very few have read the Investor Compensation Schemes Directive or understood what this protection actually means.

The €20,000 limit is not insurance against investment losses.

It is not compensation because a borrower defaulted.

It is not compensation because a bond lost value.

It is not compensation because a project failed.

It is not compensation because an investor selected a bad product.

The framework may apply when an authorised investment firm is unable to return money or financial instruments belonging to a client. This may happen, for example, because of insolvency, missing client assets or failures in the custody of client property. The EU framework sets a minimum compensation level of €20,000 per investor, although national implementation can differ. (EUR-Lex: https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX%3A32020R1503)

The critical distinction is this: The compensation scheme may protect the return of client assets in specific circumstances. It does not protect the economic value of the investment.

Yet an investor may see:

and conclude:

“My investment is protected up to €20,000.”

That conclusion is wrong.

A more accurate statement would be: “Under specific conditions, limited protection may apply if an authorised intermediary cannot return my assets. It does not protect me against the financial risk of the investment itself.”

This difference is fundamental. It is also widely misunderstood.

P2P was positioned between a bank deposit and an investment product.

The user often saw:

Psychologically, this felt closer to a deposit than to private credit. But economically, the investor was taking risks normally analysed by professionals:

The European Banking Authority warned years ago that investors could be attracted by unrealistic returns while lacking enough financial knowledge to understand risks.

P2P became popular not because millions of Europeans suddenly learned how to analyse private debt. It became popular because private debt was packaged inside a very simple user experience. A simple user experience does not reduce investment risk.

The main problem is not simply that retail investors know too little. The danger comes from four connected weaknesses.

The investor may not know:

When investors cannot analyse the structure, they replace analysis with simple signals:

These signals may be relevant. They are not due diligence.

When investors do not understand the product, they depend on other people to interpret it.

They look at:

When panic starts, they do not analyse financial statements, contracts or collateral. They watch what the crowd is doing.

This can create a dangerous chain:

A few alarming messages lead to mass exit requests. Mass exit requests create real liquidity pressure. The liquidity pressure then appears to confirm the original rumours.

This is especially dangerous for illiquid assets.

A business can be economically viable and still face a serious liquidity problem if a large number of retail investors demand repayment at the same time.

The crowd does not need to be correct to create a real crisis. It only needs to act together.

Retail investors often fail to separate:

All of these situations may be described with one word: SCAM.

The opposite mistake is equally dangerous.

When a platform becomes licensed, some investors assume that all these risks have disappeared. THEY HAVE NOT.

A licence can reduce some operational and conduct risks. It cannot eliminate borrower defaults, bad underwriting, weak collateral, concentration risk, poor recoveries or lack of liquidity.

Investors often say: “This platform gives 12%.”

But the platform does not create the economic return. The return comes from the underlying borrower, asset and risk.

The correct questions are:

Without these questions, P2P becomes a competition between attractive digital shop windows.

Appropriateness tests are intended to check whether a non-professional investor understands the product.

In practice, they can easily become an onboarding formality. A user can:

The platform receives evidence that the warning was shown. The investor does not necessarily receive real education. Clicking: “I understand that I may lose all my capital” does not prove that a person understands:

A completed test is not the same as financial understanding.

Responsibility must be shared. Adults are responsible for reading documents and understanding where they place their money. Every investor should perform their own due diligence.

But the industry also understood that complexity reduced conversion. Some businesses therefore benefited from keeping the investor’s mental model simple. The lack of knowledge was not always an accidental problem. For part of the market, it became a commercial resource.

A person who does not understand the structure is easier to sell to using:

The investor sees safety signals. The investor may not see where the actual risk sits.

The solution is not simply to publish more information. A 100-page legal document does not automatically create understanding. Platforms need to build a clear mental model of the product.

Before investing, a person should be able to answer ten questions:

Until investors can answer these questions in their own words, they do not understand the investment.

Platforms face a real conflict. They want to:

But when complexity is hidden to improve conversion, the platform creates an audience that invests easily and panics easily.

For a long-term platform, a good retail investor is more valuable than the cheapest retail investor. A poorly educated customer may be cheaper to acquire. That customer becomes much more expensive during the first crisis.

They may:

Customer education is therefore not only a compliance or marketing function. It is part of risk management.

The European market is now increasingly divided into two categories:

licensed platforms; unlicensed or differently structured platforms.

This distinction matters.

A licensed provider must meet regulatory requirements that an unlicensed provider may not meet. Licensing can improve governance, disclosures, complaints handling, conflict management, operational controls and supervision.

However, the market risks creating a new and dangerous shortcut:

Licensed means safe. Unlicensed means dangerous.

Reality is more complicated. Licensing changes the regulatory position of the provider.

It does not automatically change:

For an investor who does not manage risk, “licensed” and “unlicensed” can become little more than different selling points.

One platform sells a high return. Another sells regulatory comfort. Neither message is enough to understand the investment.

I believe it can be. An obvious high-risk product may cause an investor to be careful. A product presented as protected, regulated and safe may cause the same investor to stop asking questions.

Regulation is necessary. But regulation combined with financial illiteracy can create a new moral hazard.

The investor may believe that somebody else has already performed all the difficult work:

This creates an illusion that risk has been outsourced. It has not.

European online alternative finance grew quickly during the 2010s. The European market, including the United Kingdom, reached approximately €10.44 billion in 2017, after growing by 36% in one year. (CFRC: https://www.crowdfunding-research.org/reports)

A large part of the industry developed during a period of:

For many retail investors, the first real stress test came during the COVID-19 crisis. The whole market did not collapse.

But the crisis exposed several structural weaknesses:

The lesson should have been clear: A platform can offer daily account access while holding assets that may take months or years to recover.

The interface is liquid. The asset is not.

The market has now entered a new phase. The first phase was built around access, return and convenience. The second phase is built around licensing, investor protection and regulatory status. This is healthier in many ways.

But the underlying behavioural problem remains.

Many investors still do not understand the assets, contracts, creditor ranking or limits of regulatory protection. The market may therefore repeat the same cycle with a new story.

The old story was: “We manage the credit risk for you.”

The new story may become: “The regulation protects you.”

Both statements can be misleading when taken too far.

Retail investors are a blessing when they:

Retail investors become a curse when they:

The main risk in retail P2P is therefore not only the default of underlying loans. It is the collective behaviour of investors who do not understand the legal and economic structure, but can react to emotional signals at the same time.

This creates a separate risk category for the platform:

The first retail P2P cycle took roughly five years to move from rapid expansion to a serious stress test.

So, how long has the new era of common European regulation been with us? Since 2021, when ECSPR came into force? Or since 2023, when the transition period ended?

I am not saying that another crisis will happen on a specific date. But I believe the clock has already started.

The next crisis may not be caused by a lack of regulation. It may be caused by the gap between what regulation actually provides and what retail investors believe it provides.

And when that moment comes, the most dangerous product may not be the one that openly looks risky. It may be the one that created the strongest illusion of safety.

If you have read this article all the way to the end, you are probably also the kind of person who reads the documentation before investing.

If so, you are already ahead of most retail investors. But I want to leave you with one final thought.

Every single investment - and I really mean every single one - carries the risk of losing part or even all of your capital.

Risk is not a flaw in investing. Risk is investing.

The goal is not to eliminate risk, because that is impossible. The goal is to understand it before you invest, not after something goes wrong.

This article reflects my personal analysis and opinions based on publicly available legislation, regulatory guidance, industry reports, academic research and market statistics.

Its purpose is to encourage critical thinking and a better understanding of investment risk.

Nothing in this article should be interpreted as investment advice, legal advice, or as a promotion of, or criticism towards, any specific company, platform or financial product.

Every investment should be evaluated on its own merits and risks.