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There has been a rise in popularity of retail investing in stocks driven by higher annual % returns. The % returns offered by things like banking savings accounts or government bonds seem a lot less attractive in comparison. For simplicity and to have a monetary policy of reference, let's assume we are in the US.

If we imagined a world in which individuals only wanted to invest their money in stocks and not on any other product that has anything less than X% annually, what would be the ramifications, if any? I would also greatly appreciate further pointers to books/papers/academics who discuss this, if any.

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  • $\begingroup$ I think one issue is that if there actually was a mass shift of dollars from low-yield, safe investments to stocks, the supply of dollars for "safe" investments would decrease, driving up the return for those "safe" investments! One of the reasons bond returns (for example) are so low is because there is a lot of institutional demand for those types of assets. Is there a particular cause or shock that you had in mind that might stop the market from correcting? $\endgroup$
    – AndrewC
    Commented Jul 27, 2021 at 1:15
  • $\begingroup$ @AndrewC I framed it as a shock since I was curious about the more extrema effects that such a shock could have. In reality, I'm more interested in how these investment products will be affected if there's a paradigm shift over future generations. That is, from low-yield risk-averse investments to high-yield/risk products. $\endgroup$
    – aedcv
    Commented Jul 27, 2021 at 14:28

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That imagined world,

in which individuals only wanted to invest their money in stocks and not on any other product that has anything less than X% annually

is inconsistent with how people think about investments (and how financial markets work).

The reason is that returns are not static, but respond to demand. If everyone wants to just buy stocks with certain expected returns, it will drive up prices of stocks. This will go on until the expected return falls below the returns of the safe assets (although, in hindsight, these expectation may turn out wrong). The expected return falls with higher prices, because the discounted underlying payouts from the stock stays the same (unless something else changes, for example the economic outlook, or the money supply). Note also that as more and more people selling government bonds, their price falls and returns increase. So, other things equal, there will be a price level of stocks above which safe assets become more profitable. At that point people will stop buying stocks and invest in the more conservative option. What I describe above is a narrative (how things would move if they weren't where they are already), but usually these things happen all at the same time.

So a world as you suggest is difficult to imagine, because x% is not fixed, and people will not always want to buy a certain asset.

Of course, people may expect stock prices to continue to increase beyond their fundamental value, justifying continued higher expected returns (when including the sale of the stocks at some later point). This can go on for a while but ultimately results in a downward correction of stocks prices (a soft landing or a crash).

Note also that the choice of investment heavily depends on how much people like or dislike the risk associated with the investment (risk aversion). Some people attach so much worth to a safe investment that they will still invest in government bonds, even if stocks have much higher expected returns. However, in most cases, people prefer to hold a mix of risky and safe assets.

Key words here are:

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Yields for those things would go up (lower supply of money increases the price of money).

Yields for stocks would also go up (greater demand for stocks increases the price of stocks) until everyone owns all the stocks they can and then they would be rather low. First person to sell gets to keep it.

One day someone will figure out they can make more money by investing in formerly-low-yield investments and they will make a lot of money doing so. Other people will follow, causing the stock market to crash (low demand, high supply as everyone sells at the same time) and have negative yield.

People will stop treating the stock market as a free money machine for the next few years, although people who buy stocks at this low point will end up getting rich after everyone else forgets why it's not a free money machine and increases the demand again.

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    $\begingroup$ Seems peculiar that when demand shifts from low-yield investments to high-yield investments, yields in both categories go up. $\endgroup$
    – Giskard
    Commented Jul 27, 2021 at 9:09
  • $\begingroup$ @Giskard only temporarily in the latter case. Bond yields are inversely correlated to price while stock yields are (not inversely) correlated to price changes. Bond yields are driven by interest rates on fixed payments whereas the stock market is 80% a Ponzi scheme that thrives on hype. $\endgroup$ Commented Jul 27, 2021 at 9:31

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