"One of the surest things to lure back the retail investor is higher stock prices."
Doug Ramsey, director of Research for the Leuthold Group, a Minneapolis-based investment research firm, shared those words of wisdom last month, when he and 10 other money managers came to the Star Tribune to offer their outlook for 2011. How right he was. After years of shying away from stocks, the latest mutual fund flow data show investors are giving the equity market another try, encouraged by a second year of double-digit gains.
And when the market reverses its course, no doubt some investors will abandon it again, waiting on the sidelines until they're confident enough to repurchase the stocks they sold. The fact that we're programmed to do exactly what we shouldn't do shows in the returns we earn.
The annual study by financial services research firm Dalbar reveals that average investors never come close to earning what they would have had they stashed their money in the Standard & Poor's 500 and forgotten about it. Over the past 20 years ending in 2009, equity fund investors barely beat inflation, earning an average of 3.17 percent, compared with 8.20 percent earned by investors who stuck with the S&P 500.
Ramsey's own research shows that during the months when investors bought more stock funds than they sold, the price-earnings ratio of the market was close to 21. In the months when they were net sellers, the p/e ratio was around 14. "They are literally buying high and selling low," he said.
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So how can we change this damaging behavior? Well, being aware of our tendency to blunder is a good start. Our panelists also shared several ideas. "We have to go back to educating the consumer on investing and not trading and renting stocks," suggested small-cap portfolio manager Beth Lilly. "These are long-term investments and we're buying businesses, we're investing in businesses, we're investing in the future economic growth of America. We're not renting stocks," she explained, referring to a short-term mentality that she thinks is influenced by hedge funds and breathless cable-TV coverage of the markets.
David Joy, chief investment strategist for Columbia Management, suggested that investors focus too much on "big-picture negatives" -- the deficit or the unemployment rate. "They don't focus on the fundamentals that might drive our market higher," he said, and they need to shift their mind-set.
Russell Swansen, Thrivent Financial for Lutheran's chief investment officer, hopes that by pointing out illogical investments -- such as buying expensive corporate debt rather than the company's higher-paying dividend-yielding stock -- investors can be saved from making emotional decisions.
"Sometimes laying out some facts that they can understand helps them come to the right conclusion," Swansen said.
It's hard to teach investors to go against the human instincts to follow the crowd and to flee from risk. And some money managers suggest the effort is futile, despite a growing body of behavioral finance research that gives us a peek inside our noggins to understand why we invest the way we do.
But I'm with Phil Dow, director of equity strategy at RBC Wealth Management, who thinks we can't throw up our hands and say investors can't be saved from themselves. Investors need help more than ever given current economic and workplace challenges, he said.
"People are the captains of their own outcomes now with the demise of the defined-benefit plan. We've got to educate people," he said. Dow suggested we start with the classic book "Winning the Loser's Game: Timeless Strategies for Successful Investing," by Charles Ellis.
Marcus Winbush, a portfolio manager for the Rochester, Minn.-based financial planning firm Breneman Winbush & Associates, has the simplest advice of all for improving our investment returns. "I would tell the retail investor to trust their gut, then do the opposite."
