It's human nature to think that you're better than average at most things – driving, lawn care, defusing nuclear devices. ("Step away from there. Everyone knows it's the red wire you have to cut.") The one exception may be investing. Survey after survey shows that individual investors are lousy at investing – and in fact, individual investors' rotten skills are a legendary Wall Street indicator. When you see the individual pile in to one area of the market, sages say, the smart money gets out.
The problem is that all these surveys are offered by companies that sell financial advice, and that in today's marketplace, most of the money flows are controlled by professionals, who really are the herd on the Street. While seeking advice is a wise thing, individuals aren't the nitwits they are portrayed to be, either.
Let's start with the notion that individuals are rotten investors. This stems from the 1920s, when the smart money really did have an edge. Many of those edges are now called "illegal." Large pools of money would combine to run up certain stocks, or send them tumbling, and the little guy was always in at the top and out at the bottom.
An apocryphal story has Joseph Kennedy, the late president's father, selling his stocks when offered a tip from a shoeshine boy. If everyone, including shoeshine boys, were in the market, he figured, there was no one left to buy stocks.
A favorite way to measure what the dumb money – individual investors – are doing is to look at the inflows of money to stock mutual funds. (We're talking purchases minus redemptions, or net new cash flow, in fund industry parlance.) In the 12 months ended April 30, investors ! have poured an estimated net $158 billion into stock mutual funds, which is a very large number indeed.
Golly. Those silly mutual fund investors. Bad things must be about to happen to the stock market. But there are three things wrong with this argument.
• Fund investors have been largely right. The Standard and Poor's 500 stock index has gained 18% during that period. Had you exited the stock market because you saw an influx of mutual fund investors, you would have been wrong.
• Fund investors are largely conservative. In March, the latest data available from the Investment Company Institute, the funds' trade group, showed investors had $7.9 trillion in traditional stock funds and $1.4 trillion in exchange-traded stock funds. Holy cow, that's a lot of money. But total mutual fund assets, including ETFs, were $16.3 trillion, meaning fund investors were 55% invested in stocks. By most accounts, that's a highly conservative position, especially when you consider that $2.6 trillion was in money market funds.
• Most fund investors use some form of professional help. Sixty-one percent of individuals own mutual funds outside of retirement plans. Of those, 81% bought their funds from an investment professional, the ICI says. Inside retirement plans, such as 401(k) savings plans, about 34% of investors get some form of help, with the most likely source of help being a target-date fund, says a study by Financial Engines, a company that offers financial advice, and Aon Hewitt.
The latter point bears some further examination, especially if you plan to use mutual fund flows as a contrary indicator. Just 18% of fund investors buy their funds directly from a fund company, the ICI says. The majority, but not the vast majority, use some form of professional help when they purchase funds. If you're going to argue that the individual is the dumb money, and that that mutual fund flows are a good indicator of the dumb money, you have a fundamental contradiction to deal with.
Your b! est advic! e is to not try and be a contrarian, and to disregard fund flows as a contrary indicator. A real contrarian doesn't look for trends and do the opposite. The herd, whether professional or amateur, is typically right longer than you can remain solvent, as John Maynard Keynes noted. A true contrarian looks for peak excesses of behavior, which is a lot harder than it sounds – and also why there are so few successful contrarians around.
Instead, you should try and figure out what combination of stocks, bonds and money market funds will allow you to reach your goals and sleep at night. For many people, this involves paying a professional for advice, and if that gets you to where you're going, then it's money well worth spending.
The Financial Engines survey, for example, shows that many investors are using target-date funds poorly. These funds manage your portfolio so that when you arrive at retirement, you have a proper mix of stocks, bonds and money market funds to see you through your golden years. Ideally, you should put all your money in one target-date fund and forget about it. Most people, however, seem to be just adding a target-date fund into their mix of other investments, which defeats the purpose.
And many financial professionals do lean toward low-cost funds, which is one of the single best things you can do to improve your long-term performance. So don't hesitate to seek financial advice if you feel you need it. But you're probably not as dumb as self-serving surveys would have you think.