Small investors get no respect. When they’re leaving the market, it usually means the market is heading up. When they’re investing in the market, it usually means the market is heading down.
Some professionals even use the actions of small investors as an indicator of the market’s direction. To make money in the market, do the opposite of what the small investor does.
As evidence, consider the stampede from the stock market that took place in early 2009. Many investors stuck it out through major losses in 2008 and finally, unable to take any more financial pain, they exited the market – just before the historic rebound that began in March 2009.
They’ve been tentative about getting back into the market and seemed to be gaining renewed faith in the market again until May, when the “flash crash” spooked them all over again.
So does that make this an ideal time to invest in the market?
Before you sell all your earthly belongings and bet your life’s savings on a market rally, consider that small investors have had it right for the most part in recent years. Investors withdrew more money from equity mutual funds than they put in during 2002, 2007, 2008 and 2009, with that three-year period marketing the first time withdrawals exceeded investments since 1979-1981, according to the Investment Company Institute (ICI).
This year, inflows beat withdrawals in January, March and April, but withdrawals exceeded inflows in May. Again, small investors have not been far off.
Small investors have jumped into bonds and other investments, and have kept much of their savings in cash. But how have they fared compared with consistent stock investors?
“The S&P 500 stock index has fallen at an annualized rate of 3% a year over the past 10 years, including dividends and controlling for inflation,” according to The Wall Street Journal. “Long-term Treasury bonds show a gain of 5% a year during that same period, after inflation. Gold is up 10% a year and real-estate investment trusts 8% a year.”
The market exit by small investors is driven not only by fear and poor performance, but by need. Dollars invested in stocks increasingly have been needed to pay off debt. Why invest in an uncertain market when your funds could instead be used to pay off credit card debt? Given the impact on credit scores and high interest rates, paying off debt is often the wiser use of limited funds.
Unemployment fears and the aging of baby boomers are also having an impact on investment behavior, according to Dr. Joe Duarte’s Market IQ.
In addition, data from the ICI shows a drop in risk tolerance among young investors. In 2009, just 30% said they were willing to take above-average risk in the stock market, down from 37% in 2008. The number willing to take below-average risk or no risk at all rose to 20% from 14%.
So what does it all mean? We’ll explain in our next post.