Do you hear that loud noise? It's the sound of the stock market crashing.
You don't hear it? Well, 7 out of 10 institutional investors do -- or at least they think they will. These men and women are the so-called "smart money" who manage mutual funds, college endowments, and private and public pensions. In their huge portfolios worth millions or billions of dollars, they invest in multiple asset classes and use different strategies involving the yield curve, currencies, commodities, equity put options, hedging, private equity -- you name it.
Seventy-one percent of these money managers from Western Europe and North America believe "a significant tail risk event is 'highly likely' or 'likely' to occur in the next 12 months," according to aiCIO.com, which cited a survey by State Street Global Advisors.
Tail risk event -- that's the risk that "an investment will move more than three standard deviations from the mean," according to Investopedia. In other words, the smart money believes the markets will get hammered sometime over the next year.
Uh-oh. Here we go again. When depicted on a chart, the Standard & Poor's 500 index, a stock market index of 500 large American companies, used to look like a large mountain with a steady, though craggy incline. But in recent years, it resembles a mountain range with several peaks and valleys.
What the smart money worries about
Their major worry: the eurozone crisis and the possibility of global recession resulting from slowing growth in Europe and China. Just in case you're just skimming the headlines and not paying too much attention to all those protests by the proletariat in Spain and Greece, you might want to start taking notice since the smart money does.
I'm reminded of a Wall Street Journal story published in January 2011 titled "Slow and steady saving still pays," by Tom Lauricella. Using data compiled by Financial Engines, Lauricella looked at what happened to a young person's portfolio if she started investing in the Vanguard 500 index fund at the turn of the century. That fund mimics the S&P 500.
In the analysis, this hypothetical person began contributing 6 percent of her $40,000 salary, or $200 a month, to her 401(k) plan in January 2000, receiving a company match of 3 percent, or $100. And the study assumes she received 3 percent raises each year, so the amount of her contributions increased accordingly (in other words, the second year, she contributed $206 a month and her company, $103, etcetera).
She invested through the two protracted bear markets of the 2000s, and her portfolio suffered severe losses in those times. But about 11 years later, in November 2010, this hypothetical investor had accumulated nearly $52,000 in her account, with only $30,470 of that money coming from her own contributions. The rest came from her employer and the market.
She would have done even better had she diversified her portfolio. But the point is that even if a "black swan event" occurs -- that's an unexpected event with great consequences, such as the 2008 financial crisis -- if you continue to invest through it you will be buying stocks at fire-sale prices. Then, after the market rebounds as it invariably does, you will find yourself in good shape.
So I don't think individual investors need to invest like the smart money to do well. What do you think?
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