‘Dumb money’ acting smart while institutions jump ship

Ordinary investors not panicking in coronavirus crash, data strongly suggests

A trader on the trading floor of  the New York Stock Exchange. File photograph: Johannes Eisele/AFP via Getty Images

A trader on the trading floor of the New York Stock Exchange. File photograph: Johannes Eisele/AFP via Getty Images


Ordinary investors are generally seen as the “dumb money” – panicky, emotion-driven souls who buy in the good times only to bail out in the bad times. If that’s the case, then many investors will have sold at the height of the recent market mayhem. But what if it’s not the case? What if most people are staying calm and sitting tight? What if the dumb money isn’t actually that dumb? Ordinary investors’ unenviable reputation, coupled with the usual multitude of scary headlines about crashing markets and widespread panic, means many will assume investors were bailing out en masse during the recent sell-off. In fact, Ritholtz Wealth Management founder Barry Ritholtz notes the average client at index fund giant Vanguard made only very minor asset allocation changes in the initial stages of the sell-off. Those that did largely chose to move their money into stocks rather than bonds or cash.

As for trading activity at Vanguard, it more than doubled, but remained tiny on an absolute basis – 1 per cent traded each day over a two-week period, compared with 0.4 per cent on a typical day. Similarly, Ritholtz notes that clients at fund firm Fidelity were overwhelmingly buying rather than selling on March 9th, when US indices sank more than 7 per cent. The recent price swings have been wild, of course, and equity trading volumes have been “off the charts”, as RBC strategist Gerard Cassidy put it recently. However, the data largely suggests the sell-off has been “more institutionally than retail driven”, says Ritholtz.

Sitting tight

There’s nothing new in this. Trading volumes hit record highs when stocks plunged in August 2011, but 98 per cent of Vanguard clients made no changes to their portfolio. At the height of the global financial crisis in October 2008, 96 per cent left their accounts untouched.

“We are somehow misled into believing that ‘everyone’ is dumping stocks and getting out of the market,” Vanguard said in a 2011 report, but those trading “are a very small subset of investors”. Vanguard clients “tend to be stay-the-course investors” and may not be typical, says Dan Egan, director of behaviour science and investing at online investment company Betterment.

Nevertheless, Egan dismisses the “myth of the panicky individual investor”, recently relating how he was granted access to the database of the UK’s largest self-directed brokerage in early 2009, when the global financial crisis was in full swing. Egan found some poorly-constructed and undiversified portfolios, but “one big stereotype wasn’t there”, he says: “broad-based panic selling”. If anything, clients “bought relatively low and sold relatively high”. So where did this stereotype come from? Egan suggests that, during market crises, time-pressured reporters in need of quotes call financial advisers, who “will probably talk about the most interesting parts of their days: the calls with clients who need to be talked off the ledge”. Reporters then extrapolate from that small sample to most investors, resulting in a stereotype that they are “reactive, panicky, and easily swayed by the news”.

Dalbar report

Another source might be the oft-cited Quantitative Analysis of Investor Behavior reports from US firm Dalbar, which suggest that ordinary investors chronically underperform the funds in which they are invested.

According to Dalbar, the average US equity fund investor earned just 5.04 per cent annually over the last 30 years, compared with 9.96 per cent for the S&P 500 over the same period. Investors tend to sell in the bad times and reinvest only after markets recover their value, says Dalbar, driving these “devastating” results. Dalbar’s analysis is routinely cited in the financial media and by financial advisers, in Ireland as well as in the US. Its study is popular among financial advisers. It’s not cheap – a pre-order of the 2020 edition costs $795 – but advisers presumably deem that to be a price worth paying.

One can see why; the results make a strong case for the services of a financial adviser, someone who will help their clients avoid costly, self-sabotaging investment behaviour. The problem is, while multiple studies confirm ordinary investors do indeed underperform the funds they are invested in, most research suggests the shortfall is not nearly as large as that found in the Dalbar report. One major study found the average US investor underperformed the stock market by 1.3 percentage points annually between 1926 and 2002, with similar results evident in international markets in recent decades.

Various other studies have estimated that investors underperform their funds by between one and two percentage points annually.

And gaps in investor return caused by poor timing are decreasing, according to Morningstar; between 2008 and 2018, the average investor lost less than 0.5 percentage points to poor timing. The gap does widen in times of major stress “because some investors panic and sell near the bottom, thus missing out on a dramatic rebound”, says Morningstar. Nevertheless, the overall shortfall is pretty minor, and contradicts the notion that ordinary investors are a panicky bunch. In short, the Dalbar study is something of an outlier, and a number of researchers have questioned its methodology in recent years. Author and Wall Street Journal columnist Jason Zweig has suggested people “stop citing research that has been called into question over and over and over again”. Jonathan Clements, founder of the Humble Dollar website and a former Journal columnist, goes further, saying the Dalbar study “should die, but won’t”.


None of this means ordinary investors are undeserving of criticism. Sentiment data confirms investors do get overly jittery in bad times. The weekly American Association of Individual Investors polls show bearish sentiment hit an all-time high at March 2009’s major market bottom, when stocks had already more than halved in value.

Sentiment also hit a five-year low as stocks bottomed in December 2018, when stocks had already fallen 20 per cent. The coronavirus, too, has spooked ordinary investors, with bearish sentiment recently hitting its highest level in seven years. Similarly, multiple studies confirm investors can be their own worst enemy. Research shows investors chase returns and switch their money into “hot” funds. They can be undiversified; one study examining more than 60,000 accounts at a US brokerage found the average investor held only four stocks.

They are also especially prone to the disposition effect, selling winning stocks while holding on to losing stocks. Ordinary investors also tend to focus on attention-grabbing stocks that are in the news, which drives speculative and ill-informed trading activity. Nevertheless, for all their faults, the data strongly suggests that ordinary investors aren’t freaking out right now. One explanation is most uninformed investors know they’re uninformed so they don’t bother playing the market-timing game. As Warren Buffett once put it: “Paradoxically, when ‘dumb’ money acknowledges its limitations, it ceases to be dumb.”

Additionally, says Dan Egan, remember that most people just aren’t interested in the stock market. This is especially true in retirement accounts, he says, so most people opt to do exactly what they should be doing – nothing. Either way, it seems the dumb money isn’t really that dumb. Professional investors, not their retail counterparts, are the ones more likely to be experiencing sleepless nights right now.

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