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The curse of small investors

By Sheyna Steiner · Bankrate.com
Friday, March 18, 2011
Posted: 8 am ET

In February, a colleague here at Bankrate jokingly wrote in an e-mail, "Uh-oh, investors are getting back into equities. Does this mean the market is doomed to fall soon?"

I hope not! But there's no denying that world events have put the market through the wringer recently.

Individual investors took a renewed interest in the stock market at the beginning of the year, funneling $19.5 billion into equity mutual funds in the month of January, according to the Investment Company Institute. By way of comparison, stock fund inflows totaled $939 million in December.

Equity fund inflows remained positive until March, when they slipped back into negative territory. Last week, following a precipitous one-day drop in the Dow Jones Industrial Average, Brett Arends asked in his R.O.I. column for the Wall Street Journal, "The Dow's Plunge: Should You Be Worried?"

He gave 10 reasons for feeling a mite skittish. This was the eighth reason:

The public was just starting to buy stocks again.

Oh, brother. The U.S. private investor, who spent most of the 2009-10 rally getting out of stocks, started piling in again earlier this year. According to the Investment Company Institute, investors cashed out a net $31 billion from equity mutual funds between the start of March 2009 and the end of last year. But since Jan. 1, they have shoveled a net $33 billion back in. History has frequently shown that the public gets in -- and out -- at the wrong times, buying near peaks and selling near troughs. Is it happening again? I wish I felt better about this.

The DALBAR Quantitative Analysis of Investor Behavior has shown that most investors exhibit remarkably poor market timing skills and cost themselves money by jumping in and out of the market. The annual study compares the returns of benchmark indices against the actual returns of investors. The 2009 QAIB reported that equity investors gained 3.17 percent return annualized over 20 years and ending December 31, 2009. Compare that to the 8.2 percent 20-year annualized return posted by the Standard & Poor's 500 index.

Staying put through periods of volatility is nearly always preferable to jumping in and out of the market. The QAIB also looks at how often investors guess right when it comes to getting into or out of the market. The report found that guessing right is easy when the market is on the way up steadily over time, but guessing gets a lot harder during times of volatility.

The good news, reported in the preview of this year's QAIB, is that the chasm between investors' actual returns and benchmark returns seems to be getting smaller over time. That may indicate, the study's authors extrapolate, that investors may be learning to stay put.

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