Investors (with)Drawing Patterns

7 Mar

I am struck this morning by the counter-productive nature in which investors continue to make investment decisions.  Human nature, they say, is unchanging.  This past year illustrated this well.

There’s a lot of information out there about how investors often are their own worst enemies, adding money when the markets are up and withdrawing money when the markets are down. Buying high and selling low. Emotions replacing logic.  Wall Street is the only place people run from when there’s a sale.

According to Morningstar, 2011 was the second-worst year for actively managed U.S. stock funds flows (money in versus money out) since they started tracking the data.  In the last half of 2011, investors pulled more more out of these funds than during the last two quarters of 2008.  This is a striking statistic given that markets were only down 5% in the first half of 2011 (and lost 29% in the last half of 2008, amid massive financial market turmoil and government intervention).

Withdrawal behavior has a predictable effect on managers of these mutual funds – they have to be a bit more defensive and raise cash to meet redemptions.  Often, they can’t be aggressive buyers when the markets are down.  For what reason?  Mostly due to emotional decision-making by the fund’s shareholders.  In the U.S. stock funds category, investments ought to be made with the long-term in mind.  Ideally, inflows would be predictable and smooth, with new cash added over time; outflows would follow roughly the same pattern.

Unfortunately, it doesn’t tend to work like this and investors seem forever locked in a pattern of withdrawing money at the wrong time.  Since the end of the third quarter of last year, the S&P 500 Index (not including dividends) is up over 16%.  Those selling prior to the rally may have the certainty of cash, but also certainly don’t have 16% more money than they would have if they’d stayed invested (at least at this point).

Considering withdrawing or adding money to ‘the market?’ Think about the reasoning for your decisions and remove as much emotion from the process as possible. Your financial well-being will likely benefit.


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