Bear Markets Don’t Scare Most Investors to Action

Contrary to popular belief, during times of financial uncertainty, investors reduce, not increase, the turnover of their financial assets, according to research from Strategic Insight (SI).

In fact, redemption activity tends to decline during a bear market, with the exception of brief and modest spikes during sharp down-market weeks, SI said in a report of its findings. SI attributes this bear-market behavior to investors’ psychological aversion to realizing losses.

Therefore, fears that a flurry of mutual fund redemptions will follow stock market declines, which would in turn feed further price declines and even more redemptions, are unjustified based on actual events during past stock market declines, according to SI.

Fund Redemption Patterns

According to the report, the major change for equity mutual funds in an extended period of market uncertainty, as in the past, will not be overwhelming redemptions but a decrease in new purchases. SI said steady retirement investing (including steady fund-of-fund demand and the impact of the Pension Protection Act), dollar-cost-averaging deposits, an accelerating shift from individual stock dependency outside and inside retirement plans, and opportunistic buying will prevent equity fund net redemptions from remaining sustained and large.

SI reviewed equity fund redemption patterns of the lengthy bull markets and periodic bear markets of the past two decades and found:

  • Monthly turnover rates, on average, have remained extraordinarily stable and have been trending lower, and
  • A large portion of on-going redemptions, as well as much of the temporary redemption spikes, are driven by the actions of a tiny portion of shareholders within the industry.

SI summarized by saying, “[T]he vast majority of investors are the “buy and hold” kind, and it is only a small number of very active investors (both retail and institutional) who drive up the “average” redemption rates.’

The research also found equity mutual fund money manager net liquidations of common stocks were often less than the volume of net redemptions by investors for that month, indicating that, on a short-term basis, mutual fund portfolio managers provide positive liquidity to the stock markets, counterbalancing downward price movements.

SI said that assets in mutual funds are mostly retirement money, so a long-term focus is appropriate. Over 62% of equity/balanced mutual fund assets, and around 70% of all equity mutual fund accounts, are held in dedicated tax-deferred retirement accounts (IRAs and rollovers, 401(k), variable annuities outside and inside qualified plans, etc.), the report said.

Based on its findings, SI concluded investors should be concerned about down stock and fund prices only if they plan to redeem soon, but those who will still be in the market for a long-term should find price declines a buying opportunity.

The research report is available here.