Put not your trust in money, but put your money in trust.

~ Oliver Wendell Holmes

Our financial system operates on trust. When you put your money into a bank, you trust that it will be there when you want to take it out. When you put money in the stock market, you expect ups and downs, but you also expect that over a 20 year period you will have more money to take out than you originally put in.

There have been a number of articles lately indicating that the average investor is pulling money out of the stock market, and there are also a number of theories on why that might be happening. We'll go through a few of them here, and then I'd really like to get your thoughts on some key questions as it's not all that clear to me that this disenchantment with the markets is very widespread (yet?). I still read articles everyday reminding us that this economic cycle is no different than any other, and that we need to stick to our plan, ignore our emotions, and worship at the stocks for the long run altar.

Retail Investors Heading for the Exits?

A recent Wall Street Journal article announced Small Investors Flee Stocks, Changing Market Dynamics. According to the author, “[s]mall investors' faith in stocks, which surged in the 1990s, has collapsed since the technology-stock debacle and the Enron and WorldCom scandals of 2000-2002. The 2007-2009 financial crisis only made things worse. Now, the pullback among ordinary investors means they are a declining force in a market that is increasingly dominated by professionals.”

A few of the reasons cited for increasing mutual fund outflows are:

In short, an increasing number of investors have lost faith in the integrity of the markets and those who operate and regulate them.

What If It's Still Broke?

I fully support the old if it ain't broke don't fix it model. But . . . what if we tried to fix it and it's still “broke”? One article summed up the views of 3 prominent economists in its title: World Economy: That Sinking Feeling. The better part of the article is spent reviewing many of the ideas put forth by Joseph Stiglitz in his recently published book called Freefall. (Marc Faber and Nouriel Roubini are also quoted.)

Mr. Stiglitz argues that, leading up to the crisis “America's financial markets had failed to perform their societal functions of managing risk, allocating capital and mobilizing savings, while keeping transaction costs low. Instead, they had created risk, misallocated capital and encouraged excessive indebtedness while imposing high transactions costs.” He further argues that, in spite of having averted a financial collapse for now, governments have done nothing to curb the practices that lead us to the precipice in the first place. In short, the system is still broke, in every sense of the word.

New Math for the New Normal

By now, most people who follow the financial markets are very familiar with the New Normal thesis, articulated by Bill Gross and Mohamed El-Erian of Pimco. They postulate that, for the next decade or more, we will experience a period of slower economic growth as we work off the many excesses that have built up over the past couple of decades. Many of us, including institutions like pension funds as well as individual investors, have yet to factor this new reality into our retirement planning models.

Pop from Pop Economics recently wrote about New Normal Math: How Your Investing Plans Must Change. The article goes through some of the investment return assumptions that were formerly taken for granted and now look utterly imaginary. He suggests 3 ways to deal with this reality check:

  1. Save More: Most of us will need to boost our savings rates by quite a bit in order to make up for the shortfall in investment returns.
  2. Retire Later: You can boost your retirement savings by working until you're 70 rather than 65 or younger.
  3. Earn More: This is the one that Pop thinks we're going to be hearing a lot more about in the years to come.

In short, we need all to rethink our retirement planning models.

Who's the Dumb Money Anyway?

Moving Out of Equities is Felix Salmon's commentary on the WSJ article mentioned above. He argues that investors may not be leaving the stock market because they want to, but because they have to. Many are saddled with a lot of debt and are no longer able to draw down on their home equity. In fact, some investors are selling some of their equity portfolios in order to deleverage and get their personal balance sheets in order. (See Should You Take Money Out of RRSPs to Pay Off Debt?)

Many pundits refer to retail investors as the “dumb money” because they often lag the market, buying after a huge run and selling into big declines. But Mr. Salmon wonders if the supposedly smart institutional investors will be forced to become followers as individual investors liquidate equity positions, forcing funds to sell in order to meet redemptions. He further wonders if maybe we haven't yet seen a true capitulation from equity investors as many still view stocks as “something which can and should return 8% a year, despite the fact that they've done nothing of the sort for the past decade.”

In short, the large institutions that dominate the market will eventually need to reflect the market sentiment of the average investor.

Your 2 Cents: Market Sentiment Survey

I'd like to get an informal survey of your opinions on some of the issues raised here. If you have a relatively short comment, go ahead and leave it in the comments section below. If you want to write something a little more lengthy and formal, please send me an email. I might even publish your thoughts as a guest post (with your permission). If you happen to have a blog of your own, go ahead and post your views there.

10 Questions for You to Ponder

  1. Do you feel differently about investing than you did 5-10 years ago?
  2. If you are new to investing, are you reluctant to get started?
  3. Have the market crashes of the past 10 years changed your view of investing?
  4. Do you trust our government and corporate leaders to act with integrity?
  5. Are you confident that the financial system is repaired and the economy will recover?
  6. Do you believe today's markets are structurally different than they were 20 years ago?
  7. Do you think it's realistic to expect average annual returns of 7% or better from the stock market, or do you embrace the New Normal paradigm of roughly 2% returns?
  8. Do you think bonds are any safer than stocks given the age of the current bond bull market?
  9. Have you changed your retirement plans based on your answers to the above questions? Will you do so now?
  10. If you are indeed feeling less confident in the markets, what would it take to restore your trust?

I hope that many of you will take some time to answer these questions and share your thoughts with us! 🙂