Ignore Reports of the Death of the Individual Investor

First came the Wall Street Journal's July 12 article, "Small Investors Flee Stocks, Changing Market Dynamics." Last weekend, the New York Times tagged along with the article, "In Striking Shift, Small Investors Flee Stock Market."

That's the new cool thing to do today: proclaim the death of the individual stock investor. Both articles cite the same data and come to the same conclusion: The average investor has had it and is throwing in the towel after years of poor returns.

Ain't buying what you're selling
These articles are fun reads that attracted tons of attention. But both are also misleading to the point of possibly being entirely wrong, thanks to a clever journalism tactic of citing one breezy fact followed by layers of emotion-laced anecdotal personal stories to solidify the arguments.

The foundation of both articles is mutual-fund flow data from the Investment Company Institute (ICI), which shows investors recently pulling money out of stock market mutual funds, while demand for bonds explodes. Thus, they conclude, stock investors are abandoning ship.

But all this data shows is that investors are fleeing stock mutual funds. Neither article attempts to address the truism that mutual funds have lost sway over the years as other low-cost investment vehicles, particularly ETFs, have taken their place.

Coincidentally, ICI also tracks ETF assets. And guess what? From February 2009 to June 2010, during which time investors pulled $9 billion out of stock market mutual funds, stock market ETF assets increased by more than $250 billion. Some of this reflects capital appreciation and not new money flows. But even during periods when the market went nowhere -- October 2009 through June 2010 -- stock market mutual funds outflows of $4 billion were dwarfed by stock market ETF assets increasing by $51 billion.

There's a good chance, therefore, that plenty of the money fleeing stock market mutual funds and terrorizing the media is simply moving into stock market ETFs. This isn't surprising: Many ETFs achieve everything a mutual fund can for a fraction of the cost. Who wouldn't want to exchange a mutual fund charging 1.5% for an identical ETF that charges nearly nothing? Outflows from stock mutual funds might not signal the death of the stock investor as much as they do the death of the mutual fund.

But that poses another question: If stock assets haven't been whittled away, then where is the torrent of cash flowing into bonds coming from? The answer might again be found in ICI's data, which shows investors have pulled over $1 trillion out of money market funds since early 2009. Hungry for yield in a zero-interest rate environment, that's not surprising either.

Ready for the next round
Individual investors' confidence in the stock market has surely been trampled senseless, but assuming their demise seems overstated. Consider E*TRADE Financial's (Nasdaq: ETFC  ) year-over-year quarterly results: Number of brokerage accounts? Up. Total assets? Up. Margin debt? Way up. Hardly what you'd expect from a dying crowd.

At the same time, it's well documented that bonds are currently encircled by insatiable, almost psychotic, demand, while the appetite and valuation outlook for stocks is relatively muted.

What this all shows, I think, are individual stock investors who have not given up on stocks, but are hanging on while expecting much less out of them. Any way you spin it, that's a positive development. It shows rationality making a comeback; it shows bubbles being burst; and, most importantly, it has made stock picking about as lucrative as it's been in years.

For example, the current yield on 10-year Treasury bonds is below 2.6%, and yet several high-quality stocks with durable franchises easily best that:

Company

Dividend Yield

CAPS Rating 
(out of 5)

Altria Group (NYSE: MO  )

6.2%

****

Pfizer (NYSE: PFE  )

4.5%

****

Waste Management (NYSE: WM  )

3.8%

*****

Sysco (NYSE: SYY  )

3.5%

*****

Emerson Electric (NYSE: EMR  )

2.9%

*****

Source: Capital IQ, a division of Standard & Poor's.

I'm not sure why anyone with more than a short time horizon would prefer Treasury debt to any of these companies. More than that, I'm confident there are plenty of individual investors (like you!) ready and able to exploit these opportunities.

Your death, in other words, has been grossly exaggerated.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Fool contributor Morgan Housel owns shares of Altria Group. Pfizer, Sysco, and Waste Management are Motley Fool Inside Value choices. Emerson Electric, Sysco, and Waste Management are Motley Fool Income Investor picks. The Fool owns shares of Altria Group and Sysco. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.


Read/Post Comments (19) | Recommend This Article (81)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 24, 2010, at 5:50 PM, XMFRael wrote:

    Morgan, I agree with you. Great article. Though maybe I wish I didn't. Nothing signals a bottom (and new bull market) like reports that investors have given up on stocks!

  • Report this Comment On August 24, 2010, at 6:11 PM, 123spot wrote:

    Thank you Morgan- what a help this timely article is.

  • Report this Comment On August 24, 2010, at 6:38 PM, BearishKW wrote:

    Agreed. All of this doom and gloom signals us getting very close to the turn around for US stocks. Political winds will be changing, companies are reporting profits, and the bad housing data today deserved much more than a 1.5% sell off.

    Most of the bad data is priced in. Of course be careful, but look for buying opportunities in your favorite names.

  • Report this Comment On August 24, 2010, at 6:40 PM, richie54 wrote:

    Morgan,

    In about six months you'll be able to write a "Letter to the Editor" to The New York Times and say "I told you so!"

    Keep up the fine job.

  • Report this Comment On August 24, 2010, at 7:04 PM, Momentum21 wrote:

    Agreed, nicely done. We can easily become distracted from our plans by becoming overly sensitive to the headlines or quarterly GDP projections. You articulated the point a bit better than I... : )

    The Next Bubble to Burst: Bearish Sentiment

    http://caps.fool.com/Blogs/the-next-bubble-to-burst/436693

  • Report this Comment On August 24, 2010, at 7:13 PM, rd80 wrote:

    Some of us have even been selling our mutual funds, skipping ETFs and moving the money to individual stocks. :)

  • Report this Comment On August 24, 2010, at 8:20 PM, xetn wrote:

    I don't agree that most of the bad data is already priced in. The reason: all the estimates of economic activity keeps missing their targets (results are lower than expected). We will have another huge round of mortgage defaults and we haven't even seen the coming collapse in commercial RE defaults.

    There is no real (as opposed to imagined) recovery. The only growth is in government deficit spending and the Fed inflating the money supply. China is reducing its purchases of US debt in favor of Korean and Euro debt purchases. If that reduction is not replace by someother sucker (Japan, GB) then the Fed will have no alternative but to monetize the debt. That is already happening to some degree and will result in a further weakening of the dollar.

  • Report this Comment On August 24, 2010, at 8:21 PM, unobstreperous wrote:

    Since I started investing about 10 years ago the stock market is down about 10%. Some of my stocks have fared better, some much worse. Forget bonds, I would have done better with a simple savings account. Death of the individual investor? I'd be financially better off if this individual investor hadn't been "born".

    The trend of the overall market since the 70's looks good until the 2000 or so. I wonder if something fundamental has changed.

    While I haven't sold my stocks and index funds yet, I'm consistently asking myself why...

  • Report this Comment On August 24, 2010, at 9:32 PM, alsinaiyah wrote:

    The basis of the story line sounds like the last gasps of a dying industry: newspapers. It seems the ploy is to sensationalize a story with half-truths to entice an increase in readership. Somewhere it has been lost that the reading public wants comprehensive reporting that tells an entire story; thereby, letting the reader decide the conclusion. Somewhere in the past, newspapers concluded it was their role to tell readers what to think and that could be done by only telling the part of the story that swayed the reader, or by weaving into the story the paper's bias. What a pity. What a loss for America. A valuable freedom has been hijacked by marketers selling opinion for fact. The referenced stories from the Wall Street Journal and the New York Times are yet two more examples.

  • Report this Comment On August 24, 2010, at 9:46 PM, TheDumbMoney wrote:

    The only treasury bond or bill that looks remotely appealing to me is the 30-year TIPS bond. There is an auction this month, maybe in a few days, maybe already happened. I ponied up a small bit for that, as a part of my general asset allocation strategy, on the theory that inflation, perhaps even significant inflation, at some point from years seven to thirty on that bond looks like a great bet, and I think compensates for the low interest rate, even if the TIPS adjustments are unfortunately taxed. But it's a small position.

    Non-TIPS 30-year bonds seem REALLY stupid, on down to 5-years, and bills, which are progressively less so. Items at the one or two year maturity level are a reasonable place to park savings, as it's a reasonable bet that interest rates won't go up much if at all in that time.

    Agree with the commenter who is a tad upset to find out from this great article that individual investors have not in fact totally fled the market; it means they still could flee, and at least it reduces the amount of money that could come flooding back. On the other hand, fundamentals would not justify too much of a significant increase in most stocks at this point anyway.

    However, I should point out that on the substance, I barely know what I'm talking about, though I do know how to string together a nice sentence.

  • Report this Comment On August 25, 2010, at 1:18 AM, NationalMatch wrote:

    Thank you! From what you read these days you would think that by next month we will be working with stone tools and catching rats to eat. No doubt, it's scary out there, but retail investors are taking advantage of the volatility and waiting for the market to rise again. The patient ones will be rewarded. Good common sense article.

  • Report this Comment On August 25, 2010, at 3:09 AM, velodad wrote:

    I get a bit ruffled, (I really shouldn't anymore), when the word pushers and talking heads report, "investors fleeing stocks".

    For every unit sold.. a unit is also bought! One mans "profit taking" or "bailing out of fear", is countered by some fool (like me) buying an under appreciated, under-valued, bargain opportunity! I guess they are more interested in show-business than the explaining the dynamic reality of free-market business.

    My father's wisdom from 50 years ago remains.. "The market goes up, the market goes down and then it goes back up again."

  • Report this Comment On August 25, 2010, at 5:23 AM, quaternion2 wrote:

    Having read all the comments, It sounds to me that wishful thinking abounds.

    Instead of talking about what it is that is wrong with journalists, why isn't anybody showing meaningful evidence of a market rebound? I'd invite anybody able to bring convincing evidence of a market sustainable rebound to write about it.

    Kind egards

  • Report this Comment On August 25, 2010, at 9:20 AM, f3b wrote:

    I am a small investor, learning as I go along. I did not major in economics. Neither can I carry around in my head all of the initials jargon that's tossed around with such smugness by those in the know. I would appreciate if in your articles you would define an abbreviation when you first use it, as you did for ICI in the above article. However, when it came to ETFs, the only things I could come up with was Extra Terrestrial Fantasies and Empty This Fund! What is ETF an abbreviation for?

  • Report this Comment On August 25, 2010, at 9:51 AM, TMFHousel wrote:

    Thanks for the comments, everyone.

    @quaternion2

    "Instead of talking about what it is that is wrong with journalists, why isn't anybody showing meaningful evidence of a market rebound? I'd invite anybody able to bring convincing evidence of a market sustainable rebound to write about it."

    The market has clearly gone down. No further argument needed there. The end of this article argues that certain parts of it are cheap, which was my way of suggesting a pending rebound.

    @f3b

    "What is ETF an abbreviation for?"

    Apologies. ETF = exchange traded fund. More here: http://www.fool.com/investing/etf/2010/06/17/what-the-fool-i...

    -Morgan

  • Report this Comment On August 25, 2010, at 11:14 AM, sept2749 wrote:

    Great article - great timing. It seems that the "lull" in the market (to put it mildly) is fueled by emotion - sentiment and not how strong and solid a company is.

  • Report this Comment On August 25, 2010, at 12:43 PM, SteveTheInvestor wrote:

    We got the best return I could find by closing our money market account and putting the entire amount on our mortgage. An instant and guaranteed 5.4% return. The mortgage is almost paid in full now.

    I figure that if they only want to pay out an almost immoral rate on our savings, I'm not going to play their game. I'm not going to borrow any more. Let them lend to some other sucker.

  • Report this Comment On August 25, 2010, at 1:02 PM, kwl1763 wrote:

    I agree with Steve above. There are lots of ways to earn better then bonds returns right now. Certainly there are some good safe dividend in the 3% yield range but even if you have a 5.5% mortgage after tax that is still better then bonds and it's 100% certain. Car loans, etc. I've paid off my cars in the past 6 months or so (even though they were both under 5%) Now I'm double paying on my 4.75% mortgage the money I would normally allocate towards bonds or conservative investments.

    Also a comment to the above saying there is always a buyer for seller that is correct but just like everything else it's supply and demand. If you have more sellers prices go down, more buyers prices go up. If enough people sell and go into bonds you get a reallocation where bonds go up in price and stocks go down. You are seeing that a bit in this market. I also think the market is depressed as people do things like pay down credit cards. Credit card balances are at an 8 year low. It's a great thing but it means people are being smart rather then investing in the stock market and paying themselves that 100% lock of paying your CC down. All good things in the long term in my opinion. The consumer is deleveraging, paying down high cost debt and taking less risk. Overall that is more healthy and sustainable. Just a bit painful getting there.

    One last thing that seems to be going on is a classic case of needing to zig when everyone is zagging. With bonds where they are and everyone piling in them it's the last place I want to go. Stocks are the "risky asset" again that no one wants to touch. Probably a good sign for the long run stock return.

  • Report this Comment On August 30, 2010, at 5:28 PM, seacraft23 wrote:

    What do you get when you cross and bull with a bear? A Fool!

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