When markets crumple, the culprits usually aren’t the smallest investors, but the biggest.
So far, most individual investors have remained steadfast as stocks have been pummeled by fears that the coronavirus could turn into a pandemic. If they continue to keep their cool, small investors might even get to buy bargains as the big money bails out.
Professional investors tend to move the fastest when a market suddenly turns. That’s largely out of self-preservation, because the biggest risk they face is being so out-of-step with the market that their clients fire them. That can lead the pros to chase the market trend too far and too long.
“Institutions sell more than individuals when there is a large stock-market drop,” finance professors Patrick Dennis and Deon Strickland found in a 2002 study. They also showed that the more widely a stock is held by big investors, the greater its trading volume during sharp market drops.
And the stocks dumped by the biggest investors on down days tend to outperform the market over the ensuing six months. Selling by institutions when the market falls at least 2% “drives prices below their true values,” the researchers concluded.
Patience is a luxury that individual investors can afford. Money managers must focus not only on analyzing what assets are worth, but also on “anticipating what average opinion expects the average opinion to be,” as John Maynard Keynes wrote in 1936.
That’s because the pros are in a never-ending struggle to attract new funds. For professionals seeking to maximize their fees, it’s rational—at least in the short run—to buy even more of the most-overvalued stocks when their prices are rising.
Once performance falters, portfolio managers who owned—and then sold—the most popular stocks won’t be punished as badly as those who made unorthodox picks. “Worldly wisdom,” wrote Keynes, “teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”
When institutions sell, they often get rid of their most-liquid holdings first, because those are the easiest to sell at the best price.
A survey of more than 16,000 individual investors by Vanguard Group, the giant asset manager, shows how drastically their attitudes differ from those of big institutions.
Vanguard has been repeating this survey every two months since early 2017. The results suggest that individual investors have become a major force for moderation in the financial markets.
Individuals consistently expect U.S. stocks to return about 5% over the coming year, the Vanguard survey shows. That’s only half the historical average of 10% annually, counting dividends.
Among those individuals, nearly 60% forecast one-year returns between 0% and 6%, and just under 70% predict 10-year average annual returns in that same range. Professional investors often project returns in excess of 7.5% annually.
After stocks stumble, the survey shows, individual investors do predict lower future returns—but not by much. And when stocks are doing well, these investors make rosier forecasts—by a small margin.
From September through December 2018, as stocks fell almost 20%, the Vanguard investors’ forecasts of returns over the coming year dipped to 2.7% from 4.8%. By February 2019, however, as the market bounced back, investors projected that stocks would earn 4.9% over the next 12 months.
But, the Vanguard survey finds, these investors don’t tend to buy more stocks when they become a little more optimistic or to sell when they turn a bit pessimistic. Unlike professionals, they often change their opinions without feeling obligated to act on them.
Of course, Vanguard’s clients might be less interested than the general investing public in chasing hot returns, trading frequently or trying to time the market.
According to Vanguard researchers Stephen Utkus and Jean Young, the typical investor in the survey is 61 years old and has been a client for 17 years. The median account value is about $221,000, with about 72% in stocks. The typical annual turnover—a measure of how often an investor moves money around—is only 10%. (Mutual-fund managers trade at more than six times that rate, according to Morningstar.)
So the people in Vanguard’s survey might be unusually placid. And individual investors, overall, have been rewarded for their patience so long that there’s some risk they’ve turned complacent.
This is the longest bull market on record, according to S&P Dow Jones Indices—running more than 131 months without a 20% decline from its latest high closing price. Over that period, stocks have returned more than 490%, including dividends. Last year alone, the S&P 500 (.SPX) rose 32%.
A big tumble would shake that confidence.
Let’s remember, though, that panic is rare—in markets and in life. During the Nazi bombardment of Britain in World War II, most people remained so levelheaded that the “neurosis centres” opened by the government to counteract the expected effects of mass panic were seldom used.
No one knows how far the fear over coronavirus will extend or how much stocks will fall in response. What we can be fairly sure of is that individual investors are likely to be among the last—not the first—to sell.
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