You’ll let a friend walk your dog, drive your car or watch your teenager. Would you let them — or someone you don’t even know — invest your money?
That’s the idea behind “mirrored investing,” an invention that could be one of the most dramatic experiments in the world of online investing since the ability to place trades over the Internet shook up the brokerage industry more than a decade ago.
As crazy as it might sound, a new breed of online services and brokerages are betting that investors don’t just want to meet and chat with other investors, but also turn control of their entire portfolios over to them. It’s such a new development that
Mirrored investing allows you to essentially turn the keys of your portfolio over to another investor — sometimes a friend, other times a stranger. When that other investor makes trades in their own account, the trades are executed, or mirrored, in your account at virtually the same time.
If the investor you’re following makes money, you ride along with them to riches. But if they flame out and lose money, so do you.
Mirrored investing brings social networking, so far just a technology used to trade photos, gossip and news with friends, into arguably the most private and important nooks of people’s lives: their portfolios.
This “goes beyond sharing. This is attaching,” says Joseph Fox, CEO of Ditto Trade, a brokerage firm created a month ago to offer mirrored investing. “You can now connect to investors who have been successful and put jumper cables on their trades.”
The concept of mirrored investing has been bandied about for years, but the theory is going into practice quickly as firms are making it happen. Ditto Trade is registered with the regulatory body FINRA and is opening accounts. Brokerage giant TD Ameritrade offers mirrored investing to customers through a service called Autotrade.
Mirrored investing is also being offered by firms that aren’t brokerages, including Wealthfront and Covestor. Another brokerage firm, Folio Investing, is readying its mirrored investing site for 2011.
Firms make it happen
The time is now for mirrored investing, advocates say. It’s technology that lets individual investors compete with Wall Street while they’re outgunned by high-powered trading computers that buy and sell stock at the speed of light and they’re blocked out of the research generated by high-price research services, Fox says.
It’s ideal for investors who recognize that it takes time, dedication and experience to research the stock market but who don’t have the time themselves to dedicate to it, Fox says.
“I’m a market idiot. Placing trades on my own is something I can’t do,” says Darlene Gousios, 44, of Elgin, Ill., who started following a trader on Ditto Trade three weeks ago.
Meanwhile, there are many talented money managers who don’t want to fuss with the hassle of running a mutual fund, says Wealthfront founder Dan Carroll.
Wealthfront’s technology allows investors with smaller portfolios to follow the trades of large money managers, who typically shy away from taking on small accounts, says Bill Winterberg, a financial adviser technology consultant. It’s worth these money managers’ time as they collect fees from those who follow them of up to 2% of their portfolio value.
The concept of mirrored trading is simple and will be familiar to anyone who has used social-networking sites such as Facebook and Twitter.
The first step is to find another investor you’d like to connect with. The mirrored investor sites provide tools to help you find other investors who have had strong performance. You can narrow your search to find investors who are succeeding with a specific strategy, such as focusing on large U.S. stocks or foreign stocks.
Once you find an investor you’d like to follow, you consent and then you’re connected. If that trader makes a trade, it’s made, in proportion to the size of your portfolio, in your account. It’s based on the idea that some investors have the talent, time and energy you may lack to beat the stock market.
A question of control
The concept of following other investors is just the digital version of the way many investors have prospected for stocks for years. Investors have long traded stock tips with relatives at family picnics. And investors have been chatting about stocks online since the early days of the Internet in anonymous chat rooms.
Yet most of the larger and more established brokerage firms, including those at the forefront using social networking in various ways, say mirrored investing goes too far. Not only can it violate investors’ trust if trades go bad, it’s counter to the trend of investors wanting to take control back, not give it away.
There’s also the danger of investors giving control of their portfolios to strangers with inappropriate strategies, Winterberg says. “It would be unfortunate for a near-retiree to mirror the trades (of an investor) … who turned out to be a 19-year-old high-risk options trader,” he says.
Brokerage TradeKing allows investors to view each others’ trades if they agree but has no plans to add mirrored investing, says CEO Don Montanaro.
“There’s a reason we haven’t done that,” he says. It’s a bad idea for investors to mirror the trades of a hot investor, only to suffer once that trader’s streak runs out, he says.
Then, there’s the matter of control. Many TradeKing investors like to see what other investors are doing, but “That’s a far cry from turning the keys over to them,” he says.
Mirrored investing has been tried before in various forms unsuccessfully already, says Michael Raneri, CEO of brokerage firm Zecco. Before changing its name, Wealthfront was KaChing, a mirroring service designed to pair investors with other investors.
Demand for its mirrored investing offering is not huge, says Nicole Sherrod, managing director of the TD Ameritrade’s trader group.
Investors have legitimate concerns with mirrored trading. “You’re placing a lot of trust with the person making the trading recommendation,” she says.
Worries about fraud
There are also more serious concerns, too, as some worry about ways the technology could open up new avenues for securities fraud. It’s possible, for instance, for an investor who is being widely followed to illegally profit from the fact that he controls captive buyers.
One of these traders, for instance, could buy a stock in a separate personal account, then issue the same order in the mirrored account, pushing up the price as all the following accounts buy the stock as instructed.
He could then sell the stock in the private account at a profit, before selling in the mirrored account triggered more selling and, thus, a lower price. In a way, that would be a version of the old “pump and dump” scam.
There is reason to be mindful of the risks. Mainstream social-networking sites have already been used in an alleged securities fraud. The SEC charged two Canadians in June for using social-networking sites Facebook and Twitter to tout penny stocks and mislead investors by predicting big jumps on the stocks’ prices.
Executives at the mirrored investing sites say they have safeguards against fraud.
Covestor, for instance, won’t let an investor who’s being followed initiate a stock trade that would result in trades accounting for 15% or more of that stock’s daily activity, says CEO Perry Blacher.
He says this limitation severely curtails any influence a single investor could have on the market, even if that investor has a wide following.
Another knock against mirrored investors are fees. With Ditto Trade, you pay $4.95 per transaction, either buying or selling. But those commissions can add up if the investor you’re following trades frequently. Covestor charges an annual fee of between 0.5% and 2% based on the assets invested.
Mirrored investing is a potentially dangerous innovation for investors, says Chris McIsaac, head of Vanguard’s Portfolio Review Department. He fears some investors might get a false sense they can beat the market if they just tied up with a trader on a hot streak.
Tracking performance is just one of the many variables that goes with measuring which investors have skill, and even then, choosing winners is something that’s nearly impossible to do, he says.
“I don’t want to disparage these efforts, but I encourage anyone considering investing this way to evaluate carefully the person who they are investing alongside,” he says. “I’m skeptical.”
– article from Matt Krantz, USA Today