Equity Investors Gloss Over Market Risk

New research from The Vanguard Group suggests the watch phrase for equity investors should be: if it sounds too good to be true, it probably is.

Vanguard asserted in its research report, “Equity risk and time: A survey of U.S. investors,” that plan sponsors need to counsel the gung-ho equity investors to give them a more realistic view of equity risk, and remind participants that stocks have often, but not always, outperformed less risky portfolio holdings over time.

After polling 3,012 U.S. investors about their equity investing behavior, Vanguard found 31% believe the equity market “always” does better than safer investments, if held long enough.

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Vanguard researchers John Ameriks, Anna Madamba, and Stephen P. Utkus said the 31% are more likely to invest in the stock market generally and more likely to hold equity allocations of 60% or more. During the 2008–2009 market downturn, overconfident investors were more likely to engage in market-timing behavior (selling out of stocks entirely) or contrarian behavior (increasing equity exposure in falling markets).

“In particular, stock market education efforts should point out that, in the past, long-term investors in stocks have been rewarded with higher returns over many periods,” the Vanguard researchers wrote.  “Yet stocks remain risky no matter the time horizon, and there is no guarantee that stocks will provide superior returns simply because they are held for a long period.”

Generally, Vanguard said, beliefs about the nature of equity returns and time are strongly related to behaviors and attitudes in stock market investing. All things equal, believing in a relationship between time and stock prices is linked to a higher probability of participating in the stock market, holding a more aggressive equity allocation, trading behavior during the 2008–2009 market decline, and future expected returns.

In addition, 42% of equity investors believe that stocks “generally” outpace safe investments over a fixed period, while about one-fifth view equities as inherently risky no matter how long the equities are held.

“For such groups, investor education might emphasize a balanced approach to stock market benefits and risks, pointing out that, in the past, long-term investors have often been compensated with higher returns from the stock market than from safer investments,” the Vanguard researchers wrote. “But at the same time, such education efforts should note that stocks remain risky, regardless of how long they are held, and there are long periods in which they can underperform safer investments.”

The survey was conducted in May and June 2009, and was based on a nationally representative sample of investors ages 21 to 79 who have at least $5,000 in long-term savings or investments.

The report is available here.