Caution! Retail Investors Are Back

The Dow Jones Industrial Average hit a 17-month high recently as investors piled into stocks and riskier assets after the Federal Reserve signaled it would keep interest rates at historic lows for some time to come. Slowly improving economic indicators helped markets reach 17-month highs not seen since October 2008.

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Coupled with the market returning to previous highs, investors have added money to mutual funds for 52 weeks in a row, on a net basis (additions minus withdrawals). The Investment Company Institute recently said long-term mutual funds had net inflows in the latest week, making it 52 weeks in a row that new investments outpaced withdrawals.

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The two most notable long-run inflows to mutual funds previously were in the 1990s and most recently a nearly two-year streak of inflows that began in 2004. One does not have to think hard about what happened subsequently in those two periods (the dot com bubble; financial crisis) to know that retail investors are always late to the game.

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In total, the ICI said an estimated $506.6 billion flowed into long-term funds in the 52 weeks ended March 10 this year. Interestingly, the only category that did not increase flows over the past 52 weeks was funds operating in the U.S. equity space. Equity funds however had inflows of $66.28 billion against outflows of $8.44 billion for U.S. equity funds.

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I would hazard a guess most of the money coming back into the market (both equities and bonds – click here for BestCashCow’s dedicated bond page) is from investors who now feel “comfortable” that the worst is behind us and the market, after having seen an exponential rise in the market�over the past year. The S&P 500 is up 69% since March 9, 2009 while the DOW is up a similar 62% since the same date (to close on March 19, 2010). Investors are also moving out of cash, which yields a whopping 0%, and into higher return securities.

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New market highs coupled with large inflows into mutual funds should provide the conservative investor with a warning. Retail investors are historically the last to profit from changing trends in the market. For example, investors pulled out most of their funds on the way down after the market had already lost 25%, making things worse for themselves. The fact that they are only returning when the economic picture is less gloomy shows how they do not understand how to profit from investing.

Whenever the market is making new highs investors should be skeptical and reassess the value of the securities in their portfolios. If investors had piled in during the March 2009 lows they would have been at least 50% wealthier now. So why do they come pouring back when “certainty” returns? In investing there is only one certainty – things are uncertain.

It’s the aggressive conservative investor who understands this concept and profits.