You're Smarter Than They Thought

Mutual Funds

You're Smarter Than They Thought

Rather than sell, most people hang on to their funds during periods of market turmoil.

You've probably heard this grim fairy tale: Plunging stocks provoke jittery investors to yank money out of mutual funds. In their rush to the exits, these saps miss the first wave of the next bull market. Eventually, as the sting of their losses wears off, they realize their stupidity and jump back into stock funds just as the bear is about to pounce again. And the vicious circle of market mistiming goes on.

Frightening indeed, but not necessarily true. During times of market turmoil -- and now would certainly qualify -- stock-fund investors usually sell less, not more. Why? "They fear realizing losses," says Avi Nachmany, research director at Strategic Insight, which studies the fund industry. "Redemption activity tends to decline during a bear market, with the exception of brief and modest spikes during sharp down-market weeks," he says.

Data supports Nachmany's argument. Even in a disastrous year, such as 2002, when the market tumbled 22%, the net outflow from stock funds totaled just $27.5 billion, or less than 1% of total assets parked in stock funds, according to the Investment Company Institute, the fund industry's trade group. Nachmany reckons that only a small number of active investors drive up the average redemption rates by bailing out in sinking markets.

Most investors maintain a stable fund mix until the market improves, but they are reluctant to buy more stocks, Nachmany says. He attributes this behavior not only to more investors accepting the futility of market timing, but also to the growing flow of money into retirement accounts. Nearly 60% of investors view their retirement accounts as the main source of fund purchases, according to the ICI.


Even a trickle of redemptions has consequences, however, and sometimes there's good news. For example, a slew of fine funds that were closed to new investors recently reopened as managers seek to raise cash to invest in what they perceive to be a surfeit of cheap stocks. The group includes such solid no-loads as Dodge & Cox Stock (symbol DODGX), Fidelity Magellan (FMAGX) and Royce Micro-Cap (RYOTX).