The history of investing would be incomplete if the world halted at simple capitalism. Industrial tycoons and nobility would have been able to concentrate all the wealth in their own hands, leaving the rest of the world to fight over whatever could be scraped together through wages. Fortunately, we have options beyond working until death thanks to "financial capitalism", which is a system where profits can be made by buying financial instruments rather than by selling products or laboring for wages. In this article, we will look at the rise of financial capitalism and the birth of the individual investor. (Take a look back through the financial world's history in The Stock Market: A Look Back, How The Wild West Markets Were Tamed and From Barter To Banknotes.)
The Industrial Revolution
Financial capitalism emerged as a result of the massive amounts of corporate finance needed to power the expansion of business during the industrial revolution. The process of creating huge corporate financing operations to cover the costs of building factories, importing new machinery and merging related industries helped to kick-start a stagnant banking industry. It prompted more banks to band together in syndicates for the purpose of creating financial instruments, bonds and shares to raise funds. (To learn more about bonds, see Bond Basics Tutorial, Advantages Of Bonds and Basics Of Federal Bond Issues.)
During the early period of industrialization, there was a large pool of venture capital in the hands of the landed upper class just waiting for an investment opportunity. As the breakneck expansion of industry continued, however, the capital required nearly exhausted the venture capital controlled by the wealthy upper class. Consequently, these investments were sold to the growing middle class in the hope of tapping additional sources of financing. The first widely available investments were baskets of corporate and government bonds. (Keep reading about the middle class in Losing The Middle Class.)
As the industrial revolution spread, wealth was concentrated primarily in the hands of tycoons and then slowly trickled down in the form of higher wages to management and eventually, employees. The increase in wealth, however slow, allowed some people to attain shares and stocks through brokers. The quality of the shares bought on the advice of a "cheap" broker varied widely as many fly-by-night operations took up shop on the edges of Wall Street to fleece the newly empowered middle class. Most of the higher quality industrial shares traded exclusively through high-priced brokers that only the wealthy could afford. (For related reading, see Picking Your First Broker, Is Your Broker Acting In Your Best Interest? and Understanding Dishonest Broker Tactics.)
Stocks Take Main Street
As the revolution gave way to pure expansion of existing operations, however, quality shares overflowed the boundary. At the beginning of the 20th century, there were several publications listing the industrial companies by industry with their financials included. Dow Jones & Company news bulletins, Standard Statistics Bureau publications, and Henry V. Poor's "Manual of the Railroads of the United States" (first published in 1860 and updated yearly) became common reading material and helped investors think independently from their brokers. (Standard Statistics Bureau and merged with Poor's publishing company to become Standard & Poor's in 1941.)
After WWI, stocks quickly became all that America talked about. The number of brokers exploded to meet the rush of new investors in the Roaring '20s. It is rumored that leading up to the crash of 1929, many Wall Street insiders sold out when they heard dockworkers discussing their stock holdings. However, large figures like the Morgans (who started J.P. Morgan) were just as taken in as the rest of the market. (To learn about market crashes, see The Greatest Market Crashes.)
Enough investors were caught in the crash to turn America off investing for almost two decades.
Getting Back on the Horse
Most of America shunned investment and decided to put their faith in their company and government pension plans leading into the '50s.
It was the bull run that followed WWII and continued through the '60s that attracted the middle class back to the stock market. In the '70s, inflation and stagflation bit many households and pensioners deep enough that they began to doubt the government's ability to help everyone retire happily. The working class saw that it was the people who returned to the market who had the best chance of surviving inflation after they quit working. (To see more about inflation, check out All About Inflation and What You Should Know About Inflation.)
During the '60s, Congress took an increased interest in the market as it became apparent that the American economy and the stock market were reflections of each other. Congress had a commission undertake a special study of the market to see if improvements could be made in the structure of the market and the way that business was done.
Along with recommendations of increased automation, the commission suggested that the fee structure be altered to allow more investors into the market individually rather than forcing them to buy into funds and pension plans (with their additional fees) to get market exposure. It took more than a decade following the study for the commission's findings to become an SEC amendment.
On May 1, 1975, individual investors were given added incentive to re-enter the market. The amendment allowed brokerages to negotiate commissions with their clients. Before this, it could cost an investor as much as $100 to trade certain blue-chip stocks, but the deregulation of the brokerages brought competition to the table. As of that date, many brokerages switched from a fixed commission that included their premiums for advice/service, to a negotiated one where the commission on a trade could be reduced by foregoing brokerage services. This meant that an average investor could do the research on his or her own and then phone a broker to execute the desired transaction. Today, individual investors can process their own orders at online discount brokerages. (Learn what to look for in your online broker in 10 Things To Consider Before Selecting An Online Broker.)
Financial capitalism has created a relative economy rather than a direct one: Easy access to financial instruments gives people a way to circumvent the direct economy of labor for money and collect passive income by investing instead. The returns gained from these financial instruments depend on both the performance of the corporations they represent and the health of the market they are in, rather than any labor on the investor's part. This passive income helps investors build their wealth without having to get a second job or work longer hours. More importantly, it helps individuals prepare for a day when they will no longer need to work. Previously, it was believed that companies and the government would be able to provide at least some guarantee of comfortable retirement through pension plans, but time has proved this to be uncertain at best. Financial capitalism has given individuals the tools to secure these things for themselves.