According to the Wall Street Journal, small investors, who “tiptoed” back into stocks in the spring, are pulling out in record numbers. Their faith in stocks, surging in the ’90’s during the tech boom, has fallen once again, even after the record dip in confidence seen during the 2007-2009 Crisis. While some investors waded back in, attempting to partake of the rally of 2009 which ultimately boasted returns of upwards of 70%, new data shows that net withdrawals in mutual funds began again in May of this year and have not stopped.
At first glance, it’s easy to see why: loss of confidence in our too-big-to-fail banks, frustration with government intervention and bailouts, and the belief that the smaller investor is at a competitive disadvantage when ‘playing’ against the Big Boys are all understandable reasons for today’s average investor to exhibit this behavior. It’ll mark the history books of the newly burgeoning field of behavioral finance.
The data points in mutual fund investing paint the results of this thinking most clearly, as this is the main arena in which average investors chose to participate in the equity markets. After the 2000 tech bubble burst, investors came back to the markets via U.S. stock funds in 2003, just as stocks were entering a new bull market, according to the Investment Company Institute. But they didn’t stay: many small investors withdrew funds just before the bear market took full force, even before the sharp decline in 2007.
Apparently, the selling trend has never stopped. Individuals took a net $7 billion from stock funds in the seven days ending May 12 and $13 billion just two weeks later, surpassing deposits made during the earlier part of the year.
Not to be dismissive: in this past decade, U.S. stocks performed dead last among nine asset classes as tracked by Morningstar. The S&P 500 has fallen at an annualized rate of 3% a year over the last ten years, including dividends and adjusting for inflation. In fact, in the last twelve year period, the S&P 500 Index has gone absolutely nowhere, resting at a point today first seen more than a decade ago, without adjusting for inflation.
If you had perfect vision for where to put your hard-earned cash, you would have done best by investing in long-term Treasuries, which gained 5% per annum during that same period, even after inflation. Your principal would have been protected and you would have out-performed the markets at the same time. And as most of us know by now, gold would have been a super-star portfolio performer, coming in at 10% per year, with beaten-down REIT’s falling close behind at 8% a year.
But the small investor is clearly whigged out. Unsure of investment strategy and devoid of confidence in his or her ability to stand tall against the giants of institutional computerized trading, large-scale money managers, and combined disgust and distrust in the financial system as a whole, the issue is not just “I’m Gettin’ Outa Here.” It’s “Where Do I Go?”
Historically, investors ran to real estate when the equity markets sank. But in the double-whammy of this Great Recession, we know that the real estate market has likewise taken a beating, and investors are gun shy to park their hard-earned cash in this illiquid asset class.
So here are a few things to consider, as you look at cash that’s sitting on the sidelines:
- Do I have adequate cash reserves on hand? Cash is king. Respect its place in your total portfolio. If you have set aside enough cash to meet your needs up to the reserve level in which you find the most comfort–be it three months, six months, or even one to two years-than the rest of your funds are probably potentially investable. How much risk to principal are you willing to take?
- If you park those investable funds into fixed income investments, be aware that at today’s low interest rates, you may not keep up with long-term inflationary risks. The risks to fixed income include both credit risk of the underlying security and inflation risk. If all of your investable funds are tied up in fixed income, do not delude yourself into thinking that you are necessarily doing the best thing with these funds; if you are not vigilant about current rates and spreads, you will undoubtedly under-perform in the long term and not keep up with inflationary pressures to your net worth.
- If you enter into the equity markets, how will you determine your allocations? Do you have the confidence to calculate these on your own or do you use an Advisor? Do you even believe in asset allocation and modern portfolio theory? Take some time to study a Callan chart, the classic “periodic table” of various asset classes. If you’ve never looked at asset allocation in this light, it may provide you with an eye-opening experience.
- If you are a market participant, do you understand the inherent differences between mutual funds, exchange-trade funds and separately managed accounts? If you hold individual securities, do you know what you own and why you own them? Are you a believer in a buy-and-hold strategy or a more tactical approach to your portfolio?
- If you add real estate to your holdings, do you desire cash flow? If so, do you have the experience and expertise to hold commercial real estate or residential real estate? Are you willing to become a landlord? Do you understand all of its ramifications? Can you afford illiquidity? And if so, for how long?
- Do you value hard assets, such as art, coins, stamps and other collectibles? These assets are often the “comfort food” of a portfolio; for this reason, their significance cannot be denied. Additionally, as any serious collector will tell you, returns in these areas have the potential to beat traditional market returns.
But, as with any investment, you need to do your homework.
This is your money. Carefully and cautiously consider your steps as you move in and out of assets down your own path towards financial independence. Independence generally comes with a price. In the case of financial independence, the price is financial literacy.
NOTES: Article Cited, Browning, E.S., “Small Investors Flee Stocks, Changing Market Dynamics,” The Wall Street Journal, (2010: July 12), p.1, 12.
About Author: Carolina Fernandez works as a Registered Independent Advisor in Private Wealth Management. She holds the Series 7; Series 66 (63 and 65); Life, Accident and Health Insurance Licenses, including Long Term Care; and Alternative Investments and Guided Portfolio Management Certifications. She primarily works with Art & Entertainment Professionals and entrepreneurs in the creative communities. She holds her licenses with Source Capital Group, a boutique independent investment bank and brokerage headquartered in Westport, CT. Previously, she worked at Morgan Stanley Smith Barney, Merrill Lynch, and Dupree & Co., a municipal bond house in Lexington, Kentucky, where she cut her teeth in the industry in 1983 selling municipal bonds and government securities to institutional clients.