All advice to the contrary, the average investor does exactly the opposite of what common sense dictates.
The way to make money in the stock market is to buy cheap and sell dear. Unfortunately, the average mutual fund investor does the opposite. He (or she) buys dear when stocks are hot and prices are high, and sells cheap when the market’s cold, and prices are in the cellar.
This isn’t an elitist putdown of average investors. It’s what TrimTabs Investment Research found by analyzing retail investors’ purchases and sales of stock mutual funds.
The conclusions are really kind of depressing. TrimTabs, using data from the Investment Company Institute, the mutual fund industry’s trade association, found that by buying high and selling low, stock fund investors over the past 10 years paid about 22% more than the market’s average price.
During that period, stock fund investors’ “flow-weighted purchase price” was the equivalent of 1434 on the Standard & Poor’s 500-stock index, says Vincent Deluard, TrimTabs’ executive vice president. During that period, which ended in July, the S&P 500 averaged only 1171.
Do the arithmetic — divide 1434 by 1171 — and you get a 22.5% difference. That’s how much above the average price of the S&P 500 (and presumably above the average prices of stock mutual funds) retail investors paid. “It’s bad market timing,” Deluard says. “Retail fund investors buy when stocks are popular, and sell when they’re unpopular.”
Don’t think for a minute that the past decade was an aberration. Since 1984, Deluard says, retail stock fund investors have bought at an average price of 926 on the S&P 500 (SPX), even though the index averaged only 773. That’s a 19.7% difference. (The analysis starts in 1984 because that’s as far back as Investment Company Institute statistics go.)
“It was a lot easier (for retail investors) to buy stocks in the late ‘90s, when stocks were going up and houses were going up, than it is for them to buy stocks now, when they’re much cheaper,” Deluard says.
Deluard says — rightly, I think — that the average retail investor is misled by history. In the late 1990s, stocks were sizzling, and the previous 10 years had produced fabulous returns. Then, they tanked. Now, stocks are unpopular because they’ve had a bad decade and a bad three years despite their 75% gain from their low of 19 months ago.
Deluard estimates that half of retail stock fund investors in the last 10 years have lost 25% or more of their investment. By contrast, if you owned an S&P 500 index fund at the start of the period and just sat with it, you’re down only about 5%, because dividends have offset most of the decline in the index. For example, Vanguard’s small-investor S&P 500 index fund (VFINX) lost only 0.53% a year for the decade that ended in September.
The point of all this is to show you that retail stock fund investors, as a class, are almost always wrong.
Currently, as you probably know, investors are bailing out of stock funds at a time when U.S. stocks are relatively cheap (though not screaming bargains). They’re stampeding into supposedly-safe bond funds, which have done very well the past three years because the Federal Reserve has forced down interest rates to ultra-low levels by doing extraordinary things that it can’t — and won’t — keep doing forever.
Hmmmm. The retail crowd is selling stock funds and buying bond funds. The crowd, historically, has been wrong. Draw your own conclusions about what’s likely to happen to bond fund investors over the next five or ten years.
To repeat what I wrote a week ago: Yes, “past performance is no guarantee of future performance” is a cliché, but it’s a cliché you should heed instead of projecting past returns into the future. It’s true of stocks, and it’s true of bonds. Nuff said.
