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Amid Waves of Panic, a Sea of Calm

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Meet Nancy Stein.

Nancy is a retired real estate agent from Illinois, and she's had it with the stock market. Unnerved by market volatility, she sold almost all of her investments earlier this year. "I felt the people buying were people inside the market. They weren't the investors of the past who wanted to protect what they had or see it grow a little bit," she told The Wall Street Journal, which interviewed her for a story on investors cashing out of stocks. "Across the country, investors are fleeing the stock market for the safety of cash," it wrote.

Now meet Fritz Dixon.

Fritz is a former physician from Idaho. He, too, was interviewed by The Wall Street Journal for a separate story on investors fed up after this summer's rout. Dixon has dumped all of his stocks and says the odds are "zero" that he will ever own them again. The volatility is too much. "You can shear a sheep many times, but you can only skin him once. And I ain't gonna lose any more skin," he said.

The Journal isn't alone in profiling the plight -- and flight -- of small investors. Several media outlets have highlighted stories of investors abandoning stocks and swearing them off for good. The stories are usually backed up by scary statistics. "Investors flee stock funds at rate not seen since 2008 panic," USA Today wrote in August. Investors pulled nearly $24 billion out of mutual funds, it pointed out -- "the biggest weekly outflow since Oct. 15, 2008."

You can probably relate to these investors' frustrations. Market volatility became so erratic this summer that it often felt like a rigged game. July and August were two of the most volatile months in the modern history of our stock market, with the Dow Jones Industrial Average (INDEX: ^DJI) finishing either up or down more than 2% on nine occasions. If everyone else is fleeing, do they know something you don't? Should you be cashing out, too? Those are questions investors have undoubtedly asked themselves this year.

But take heart. Dig through the details and this story isn't nearly as frightening as it looks on the surface. As a whole, individual investors are not fleeing the stock market, and there's no reason you should be, either.

Journalists use techniques like the anecdotal lede to transform relatable personal stories into broad trends. But in a market with tens of millions of investors, what Nancy Stein or Fritz Dixon do with their investments is irrelevant. You have to look at the broad numbers to accurately gauge what's going on. And even then, you have to look at the right numbers and put them in the right context.

When attempting to show that investors are fleeing the market, you'll likely see data from the Investment Company Institute showing money flows into and out of mutual funds. So far in 2011, retail investors have pulled $50 billion out of stock-based mutual funds, which might appear like an exodus.

But mutual funds are just one slice of the investment world -- and they're a dying slice at that. Focusing on mutual funds alone ignores one of the biggest trends in modern finance: Over the past decade, mutual funds have been replaced by exchange-traded funds, or ETFs, which are far more convenient to trade and typically come with lower management fees than traditional mutual funds.

And guess what? While investors have been pulling money out of stock-based mutual funds, they've been adding money to stock-based ETFs. Year to date, retail investors have added about $20 billion in net cash to stock-based ETFs, according to National Stock Exchange. Add that to the $50 billion pulled out of mutual funds, and net stock outflows this year total about $30 billion. Consider that U.S. households and nonprofits hold more than $14 trillion of stock assets, and that's barely a rounding error -- a fraction of 1%.

Here's another figure that might come as a surprise to those proclaiming the death of the individual investor: In 2006, when the economy and markets were booming, U.S. households and nonprofits held $13.8 trillion of stock assets. Earlier this year, when investors were supposedly fleeing markets, the total stood at more than $14 trillion.

Indeed, when we checked in with some of the largest brokerage houses in the country to gauge how investors reacted to this summer's volatility, we got the same answer again and again: with remarkable calm.

At the Vanguard Group, 98% of investors didn't make a single change to their retirement portfolios in August, when market volatility peaked. "Ninety-eight percent took the long-term view," wrote Steve Utkus, who oversees the Vanguard Center for Retirement Research. "Those trading are a very small subset of investors."

Even during longer periods when markets underwent gut-wrenching drops, the percentage of Vanguard investors who called it quits was incredibly small. "We know from our research that during a financial crisis, few investors actually cash out their entire portfolios," Utkus wrote. "Yes, there is always a small fraction of investors -- 3% in the recent financial crisis -- who sell everything, so there's always someone to interview about getting out of the market. But they aren't typical investors." A Nancy Stein or a Fritz Dixon can always be profiled, but they simply don't reflect broader investor trends.

We found an even more bullish sentiment at TD AMERITRADE (Nasdaq: AMTD  ) . Over the week of Aug. 8, as markets plunged, "retail clients were slight net buyers of securities," a spokesperson said. That's not to say they weren't paying close attention. Account logins on Aug. 5 and Aug. 8 -- immediately preceding and following the U.S. credit rating downgrade and market volatility that ensued -- were up 23% from "typical volume." What's more, while the Dow was on its way to dropping 635 points on Aug. 8, call-center volumes were up 72% versus the company forecast. Yet, again, TD AMERITRADE's retail investor clientele were net buyers of the dip.

Scottrade had a similar storyline. "Overall, investors are confident and engaged. In September, Scottrade's buy/sell ratio consistently favored the buy side," said a company representative. To boot, "about 60% of investors plan to keep their investments at the same level and about one-third ... are planning to invest additional money." Rival E*TRADE (Nasdaq: ETFC  ) added a net 116,000 new brokerage accounts in the year ended Sept. 30, including 13,000 in the most recent quarter.

There is, it seems, a disconnect between anecdotal evidence and actual evidence. Vanguard's Utkus summed it up nicely: "When markets are falling, trading activity jumps, sometimes by large amounts. And we are somehow misled into believing that 'everyone' is dumping stocks and getting out of the market. But overall ... most investors have a long-term perspective and don't react to falling markets."

This is encouraging. As Ben Graham, Warren Buffett's early mentor, used to say, "In the short term, stocks are a voting machine, and in the long term, stocks are a weighing machine." Volatility is just that -- temporary ups and downs, not long-term structural fractures that should derail your goals. Graham's wisdom is as true today as it's ever been. And thankfully, it's a lesson that individual investors don't appear to have forgotten.

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

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (12) | Recommend This Article (43)

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 November 01, 2011, at 3:56 PM, memoandstitch wrote:

    Maybe you should check with the hospital. How many people reported headache and how many people couldn't sleep? lol.

  • Report this Comment On November 01, 2011, at 4:07 PM, Hawmps wrote:

    When there's blood in the streets... it's the time to buy.

  • Report this Comment On November 01, 2011, at 4:45 PM, terracomm wrote:

    agree wholeheartedly.

    some of those outflows can be traced to my doorstep.

    but i'm not out of the market.

    even low-cost vanguard offers ETF alternatives.

    you can use a generic broker and still enjoy vanguard's low-fee approach to investing.

    technology remains a constructive, disruptive force.

    for the good of investors.

  • Report this Comment On November 01, 2011, at 5:05 PM, TMFDarwood11 wrote:

    I agree, most of the people I know aren't buying and selling on a daily basis. They're adding continuously to their portfolios via DCA. They aren't selling and they aren't trading.

    As for me, I'm monitoring events, but haven't made a significant change to my portfolio, with the exception of selling 2/3 of my NFLX shares a while ago.

    My spouse continues to purchase monthly via DCA for her 401(k).

    Our net worth continues to increase, despite "as the tird whirls" financial crisis, the housing meltdown, etc. etc. I suspect that feedback is why we haven't made any significant changes. Are we concerned by the situation? Any rational person would be. But "being concerned" is not a cause to act.

    We're monitoring current expenses, and planning for a situation 20+ years out.

  • Report this Comment On November 01, 2011, at 5:23 PM, HighVoltage627 wrote:

    Hi, this is my first post here at the Motley Fool.

    I'm the exact opposite of the people mentioned in this article. I commited my first money to the market, outside of my 401k contributions, in march/april of 2009. I have been rediculously happy with that choice.

    So while article writers continue to find anecdotal evidence of people leaving the markets, myself and others (im sure there are others) have moved in. I do find it curious that no one is clamoring to interview us "newly minted" investors.

    As an aside, another great article Morgan. This is my first post, but I have been coming to Motley Fool since I started investing. Your articles have consistently been enlightening, and thought provoking. As in this article, I appreciate your ability to cut against popular consensus, and tell things as they are.

  • Report this Comment On November 01, 2011, at 6:28 PM, daveandrae wrote:

    This morning, prior to the market open, I calculated the year over year performance of my investment portfolio, which is 100% equity. Year over year, the s&p 500 was somewhere around 8%. My portfolio's Investment performance was 13.42%. More importantly, the "dollar weighted growth" of the portfolio was 17.09%, most of which came, as we all know, in the last thirty days.

    The WSJ article was written on October 5th. The market bottomed on October 4th. Thus, the people quoted in the article not only sold out at the WORST possible time, they also missed the SINGLE GREATEST MONTH TO BE A LONG TERM EQUITY INVESTOR SINCE OCTOBER 1974!

    Think about that for a second. For not only is it a horrifying juxtaposition. This data only reinforces the simple fact that there is absolutely, positively, NO correlation whatsoever between Investment performance, and investor Return.

    In fact, the two are wildly diametrical.

  • Report this Comment On November 01, 2011, at 9:18 PM, A2Matty wrote:

    I agree with all of you...this is exactly why I have loved Fool since joining, contrarian thinking. I know two investors first hand who pulled out for similar reasons to those interviewed. They still have 401(k)'s but got everything else out. One is my brother who claimed after years he never really made any money - he pulled out in 2009 I think. (maybe he should have sold now). He now owns a bunch of real estate and chases tennants for rent but loves it...and the decent returns.

    After years of investing myself, I think you just need to find your own trick to stay calm. I have a whiteboard in my office to do this. When I buy, I put down all the details. I also include a Goal Price and Target Date. I don't really worry about a purchase until one of those is met or a few analysts give me a compelling reason to worry.

    Sure, like everyone on here, I monitor my investments regularly and constantly search for my next investment. I don't know if my method is the best, or even good. But with a portfolio that holds a couple dozen stocks (not including mutuals and etf's), I sleep well knowing the boogie man won't be able to make them all fail overnight.

    Also my first post on here!

    Happy investing!

  • Report this Comment On November 02, 2011, at 12:07 AM, Merton123 wrote:

    Christmas is coming around the corner. I find it interesting how the tenor of the news is beginning to change. There is light at the end of the tunnel. The Euro Crisis has been resolved. More jobs are being added to the economy. We are also moving into an election year. Motley Fool had an article a while back - turn off the news and go out and play. Still good advice while investing in FOOLX.

  • Report this Comment On November 02, 2011, at 12:29 AM, cattywampus wrote:

    +1 I like to compare the market to a roller coaster. You get on for the first time with the other riders and feel somewhat secure, the safety in numbers effect. People start buying, the coaster starts rising along with the excitement level, the we are in for a good ride effect. The coaster reaches the peak and things change. The first timers are sure they have made a terrible mistake and start screaming and hanging on for dear life. The what was I? nuts effect. The end of season riders have been on this ride before and all have different strategies, the every man for himself effect. Then there is the old cogger you have to wake up at the end, the what ride effect?

  • Report this Comment On November 02, 2011, at 11:47 AM, DJDynamicNC wrote:

    @Darwood - exactly right. I'm using DCA with an IRA and a 401(k) and I could not be happier with the way things are going.

  • Report this Comment On November 02, 2011, at 2:58 PM, cattywampus wrote:

    @ Darwood11, thanks for the laugh, I was just reviewing a previous post you made on another article. If you can't dazzle them, I'll remember that one. Thanks, wasn't sure if you would go back so far in the articles and see my comment.

  • Report this Comment On November 04, 2011, at 12:27 PM, TMFDarwood11 wrote:


    You're Welcome!

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