October 4, 2010

The Retirement Blog: How to Lose Money and Alienate Clients

Irrational behavior misleads investors yet again

Consider the following insanity. Oft-repeated research from Dalbar Inc. finds that investors poured a record $309 billion into equity mutual funds at the top of the technology-driven market in 2000, purchasing at the highest possible price. At the same time, they pulled a record $50 billion from bond funds.

Conversely, investors put $140 billion into bond funds in 2002, while pulling $27 billion out of equity funds at the bottom of the market, selling at the lowest possible price. In both instances, irrational behavior led investors to do the exact opposite of what prudent investment required. Back then, there was time to recover before baby boomer retirement, but now it’s happening again...

As Wall Street Journal columnist Jason Zweig noted over the weekend, “The bond market is a bubble, and the little guy is blowing it.” (We love the double entendre.)

“Retail investors poured over $375 billion into bond mutual funds last year and another $230 billion thus far in 2010—even as interest rates have shriveled toward zero and the risk of future losses has risen,” Zweig writes. “Households also have yanked roughly $70 billion out of U.S. equity funds this year, though the stock market has gained 4%.”

But as much as an irrational client frustrates advisors,Zweig finds it’s a case of “physician, heal thyself.”

“Retail investors certainly don't have a good track record when it comes to buying bond funds en masse. They pumped tens of billions of dollars into them in early 1987, right before rates shot up and bonds got pounded; the same thing happened in 1994.”

What Zweig fails to notice (or not) is that the bad behavior perpetrated by retail investors isn’t exactly due to irrational performance chasing. Rather, they know what they’re doing.

“This time around, retail investors have had no choice [but to rush to bonds] if they wanted to earn income.”

So there it is. Just as the financial services sector begins to win back some modicum of trust from the investing public, they’re on track to once again blow it. They’ll no doubt justify it by saying they need to put food on the table, which should help them sleep at night.

If so, they should consider the following: Last week, Vanguard passed Fidelity in total assets under management to become the largest mutual fund family. Might there be a connection between the company’s success and the message of integrity preached by founder John Bogle? A refresher on the concept of ‘fiduciary’ is definitely in order.

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