It’s often called “dumb money” by stock market pros, and if you look at some investors’ actions the proof is in the data.
Small investors are gun-shy when they see red on the TV screen of financial shows.
After last week, when the markets went on a roller-coaster ride, financial pros caution that average investors are easily spooked and apt to wrongly jump in and out of markets based on the latest boom or crash.
“Performance chancing is dangerous to your wealth,” says Chris Brightman, chief investment officer of Research Affiliates.
A perfect example of how the small investor shoots himself in the foot: The S&P 500 over the last decade, which includes the 2008 financial crisis, has an annualized return of 10 percent, according to the Vanguard Group. But flighty investors over the same period had returns closer to 3 percent, says a new report, because they only hold a stock or fund for a short period.
This “strongly suggests that investors lack the patience and long-term vision to stay invested in any one fund for much more than four years,” according to a report by Dalbar, a fund tracking firm.
“Four years is not nearly enough for a full market cycle, notes Cory Clark, head of research at Dalbar. He points out that fund switching, even if it is only wrong a few times, destroys performance.
In the longer term, the disadvantages become even more apparent. Over the last 30 years — a period of many ups and downs — the S&P 500 returned on average 10.2 percent a year. But the average skittish equity investor only received 4 percent, Dalbar said.
That’s because small investors use sentiment rather than market knowledge to know when to get into or out of the market.
As we saw all too clearly last week, crashes can be sudden and dramatic. And yet it was only recently that some small investors started to come back into the market, says one money manager.
“It is nine years into the bull market and yet only now are people finally realizing that there is a bull market. I find that incredible,” says Richard Bernstein, a money manager with his own firm.
That means, he adds, the average investor missed a huge stock market run-up, and may only have come just in time for a scary drop.
Many small investors haven’t forgotten the traumas of 2001 or 2008.
In 2008, the average investor was hammered. Most indexes lost 40 percent, which translates into trillions of dollars that evaporated.
And in 2001, Brightman warned that indexes were over-concentrated on a small number of huge tech stocks, and sure enough, the bottom eventually fell out.
Brightman believed before last week’s correction that a similar over-concentration in a few overpriced stocks was developing.
“I think anyone with a memory that goes back more than a decade, and a little bit of curiosity, would find striking parallels between today’s environment and the late 1990s,” Brightman says.
