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The Rewards of Avoiding the Herd
by   Mark Wade  

The year 2012 was another good one for the stock market, with the Standard & Poor’s 500 Index increasing in value by about 10 percent. Since the equity market bottomed out back in March 2009, the S&P has risen by more than 100 percent.

Logically, you might think that investors would be flocking to a market such as this one. Instead, we’ve seen a continuing trend where people have been pulling money out of domestic stock funds. The past year saw net outflows of more than $100 billion from mutual funds that are invested primarily in American stocks, according to data compiled by the Investment Company Institute. The total figure for 2012 is expected to surpass the previous record of $108 billion from 2008, when the market crashed.

Meanwhile, bond funds saw net inflows of roughly $350 billion in 2012. Clearly, investors are seeking some sort of safe haven in which to put their money, but they are running scared from domestic stock funds.

It’s been this way for a while now. Ever since the stock market fell apart in 2008-2009, investors have been very wary of equity funds. As the financial sector was collapsing in October 2008, investors pulled $46 billion out of stock funds in that single month, and they’ve lost more than $300 billion in investor money ever since. Yet all those investors who withdrew from stock funds missed out on one of the greatest bull markets of our lifetime.

That points up one of the paradoxes of broad-based investing trends: The more people who are invested in stocks, the worse the market tends to do. The peak in the number of American households owning stocks – whether that’s through outright stock purchases, mutual funds, 401(k)s, or whatever - came back in 2001. In that year, coming right on the heels of the dot-com boom, roughly 53 percent of American families owned stocks.

We all know what happened then – we had a bear market, one that saw the S&P 500 lose 35 percent between the start of 2001 and the end of 2003. Not surprisingly, household ownership of stocks started to drift back downward at that point, as people got scared out of the market. The number rose again and matched that peak of 53 percent in 2007 – just before the market crashed in an even more resounding fashion.

By 2011 – when the market had achieved full recovery from the latest crash – the percentage of American households owning stocks had slipped to less than half, at 46 percent. That certainly reflects the trend of all those investors getting out of equity funds. The macroeconomic trends of recent years have understandably made people nervous and in search of safe places to park their money. At the same time, that has also meant places where investors have missed out on equities and equity funds that have performed really well.

It’s important to note that having a lot of people invested in stocks does not necessarily mean anything good about the future of that market. Indeed, it may be possible that the number of households invested in stocks is a contrarian indicator, with stocks doing better when fewer people are invested in them.

Consider what will happen when investors come back to equity funds, as they inevitably will. That will mean there is more money pursuing individual stocks, which will likely drive their prices up. When you think about all the money that has flowed away from stocks and stock funds in recent years, it is even more surprising that their share prices have held up so well.

Even without the effects of new money, though, it is clear that the people who have jumped in and out of the markets in recent years have lost the opportunity for some really solid gains. Smart investors stay away from the herd mentality and invest not because everyone else is investing but simply because it’s the wise thing to do.


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