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Stock Market Investors Are Becoming More Knowledgeable!

Stock-Markets / Stock Markets 2010 Aug 07, 2010 - 02:11 AM GMT

By: Sy_Harding

Stock-Markets

It’s quite discouraging to look at the historical performance of public investors.

For instance, the most recent annual study by research firm Dalbar Inc. shows that over the 20-year period ended December 31, 2009, the S&P 500 Index gained an average of 8.2%, but the average equity investor had an average annual return of only 3.2%. Of course, the word ‘average’ is very misleading. Over that 20-year period the S&P 500 was up as much as 50% in individual years, down as much as 40% in others, providing ample opportunity for market-timing strategies to buy low and sell high, and so not only match but outperform the index.


Yet, although well aware that the basic rule or goal of investing is to buy low and sell high, there has always been a strong pattern of investors becoming more encouraged and bullish near market tops, therefore engaging in more buying at higher prices, and more worried and bearish when significant corrections have been underway for some time, and so engaging in more selling at low prices.

Wall Street is partly to blame. As a stock-broker friend once told me it is far easier and more lucrative to sell an investor what he or she wants, a stock or mutual fund that has already gained 50% or 100%, which has everyone excited about it, but may be overvalued and have limited further upside, than to try to convince them to buy a stock or sector that is down 50% and ‘out of favor’, even though it may be undervalued and close to a bottom from which it will soon begin its own big rally.

Another form of ‘chasing performance’ and buying high, can be seen in the popularity of choosing stocks and mutual funds from the lists of those with the best performances of the previous one to three years. How popular is the strategy? The Investment Company Institute says that 88% of mutual fund buyers cite a fund’s previous performance as the primary reason they choose one fund over another.

Does it work?

John Rekenthaler, vice-president of research at fund-rating service Morningstar, puts it this way, “Investors piling into the hottest funds of the previous three-year period will be sorry, as studies show they tend to underperform over the next period, while the lower ranked funds tend to be the winners over the next three-year period.”

It’s discouraging to go back 100 years and more, after all the books that have been written and efforts that have been made to educate investors, and see the destructive patterns have never changed.

And yet this year there have been encouraging signs that public investors are indeed becoming more knowledgeable about how the market works, and seem to have done a better job with their timing.

Investors poured money into equity mutual funds in the first four months of the year, and then began moving it back out in May as the market began to top out. Since May more than $40 billion has been taken out of equity mutual funds.

More recently, even though the market was up 7% in July, trading volume tumbled as institutional investors (large pension plans, insurance companies, investment banks) and many hedge funds sat on their cash and did not participate.

And it appears that retail investors took the same approach as the institutions and professionals, right or wrong, and were also not enticed back in by the higher prices, in fact seem to have sold into the rally, lightening up even more. Investors pulled an additional $9 billion from equity mutual funds in July, selling into the strength.

It remains to be seen whether the institutions and professionals will be correct in expecting the July rally to have limited upside before the correction resumes. But this time investors seem to be following their lead rather than the always bullish lead of Wall Street.

Investors have also been pouring their money into bonds, and while many analysts, including myself, are concerned that a bubble may be forming in bonds, so far it has been working out. Hopefully, it’s another indication that public investors are becoming smarter, more knowledgeable. That would be bad news for Wall Street but good news for investors.

Sy Harding is president of Asset Management Research Corp, publishers of the financial website www.StreetSmartReport.com, and the free daily market blog, www.SyHardingblog.com.

© 2010 Copyright Sy Harding- All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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