One of the most important pieces of advice we give to our clients is to have a plan and stick to it. Whether you are five years away from retirement, have already been retired for five years, or are at the beginning of your career, you should have a plan for how to invest your money. Often times, a plan will combine a strategy for the short-term, mid-term, and long-term, but all are part of the same overall plan. The important thing to remember is that while you may need to tweak your plan as life happens, so long as your eventual goals remain the same, you should stick to your plan.
More often than not, making emotional investment decisions or trying to time the market will lead to less-than-optimal outcomes. Many individual investors who go it alone make these kinds of mistakes. From them, we can make several observations.
Individual Investors Don’t Move the Market
To date in 2019, individual investors are pulling their money out of equities at a record pace. These individual investors are moving their money out of U.S. equity-based funds and into bond and money market funds at the fastest pace since the second half of 2008 – near the bottom of the financial crisis. To date, investors have pulled over $135 billion from U.S. equity-based mutual funds and ETFs this year as seen in the chart below. Further, total money market funds are now at the highest level since September 2009.
Keep in mind the context of when this is happening. To date in 2019, the U.S. economy and equity markets are having a great year. Unemployment is low and job creation is high. The S&P 500 is having its best run in years, and the major stock indices have set multiple new record highs. It is inevitable that there will be a market pullback at some point in the future, but this equity exodus by the individual investor is not moving the market down.
Individual Investors are Often Driven by Recency Bias
For better or for worse, many individual investors are headline investors who are driven by our chaotic news cycle. If you have been paying any attention to the headlines this year, you can understand why many individual investors have been spooked out of the market: the yield curve inversion, the trade war with China, lingering talk that the U.S. is headed towards a recession, and a constant barrage of political headlines among others. To keep things in perspective, take a look at the chart below. (Credit where it’s due: Ballast’s own Brian Burton made a similar point using this same chart in our year-end video).
On the flip side, many individual investors jump back into the market when there is a hint of positive news. For example, any time you hear that we are close to a trade deal with China, you can watch the markets pop up on the news. Those individual investors who are trying to play by this strategy are simply trying to time the market. This is a strategy that rarely works as you must be right twice: when to get out, and when to get back in.
Individual Investors are Often Wrong
Refer back to the chart above about reasons to sell. Many investors got out of the market at each one of those points, and you can see the final result they missed. More recently, the chart below shows data gathered by the research firm Dalbar through the end of 2018.
Dalbar’s research tracked individual mutual fund investors’ behavior over several decades. Their research concluded that these poor outcomes resulted from individual investors making the decision to buy or sell at the wrong time. Essentially, rather than trying to beat the market, these individual investors would have fared much better had they bought a diversified portfolio at the beginning, and then got out of their own way.
Have a Plan, and Stick to It
It’s easy to be sympathetic to the average individual investor. Anyone casually investing on their own and paying any amount of attention to the news could easily be swayed by all the negativity. Once again, making rash investment decisions or trying to time the market is typically a losing strategy. There are many positive indicators of a strong U.S. economy right now, but it is possible that we are at the top of the market cycle on the verge of a recession. To avoid the pitfalls of the average individual investor: have a plan and stick to it.
Cox, J. (2019, October 12). CNBC. Investors are flocking to money markets at the highest rate since the financial crisis. Gathered from https://www.cnbc.com/2019/10/12/investors-flock-to-money-markets-at-highest-rate-since-the-crisis.html
Sommer, J. (2019, July 26). The New York Times. Investors Are Usually Wrong. I’m One of Them. Gathered from https://www.nytimes.com/2019/07/26/your-money/stock-bond-investing.html
Wursthorn, M. (2019, December 8). The Wall Street Journal. Investors Bail on Stock Market Rally, Fleeing Funds at Record Pace. Gathered from https://www.wsj.com/articles/investors-bail-on-stock-market-rally-fleeing-funds-at-record-pace-11575801002