DHWA Investment Update | 2009  Vol. #4

This Is Your Portfolio On Drugs

Remember the public service commercial a couple decades ago that started "This is your brain," and showed an egg? And then they cracked the egg into a frying pan and said, "This is your brain on drugs?" It got your attention, and although it might be considered blasé today, back then it drew great reviews.

The two charts below show similar, if less dramatic, behavior.

The first chart shows how retail investors behaved during the bear market of '08/'09. It tracks the flow of funds in and out of the market each quarter from 1/1/08. You can easily see that the money moved in exact correlation to the market direction. When the market was up, money flowed into it. The quarters where the bear market did its worst were also the times when retail investors sold, sold, sold. Translated: the retail investor was buying high and selling low, which is not the way successful investing is supposed to work.

Estimated Industry Flows into and out of Equities
January 2008-September 2009
In USD (Billions)
Source: Morningstar Estimated Net Flows Open End Ex MM and FOF.

The second chart is a study of fund flows of DFA Funds (the equity funds we use as asset class building blocks for our clients’ portfolios). As you can see, there was consistent buying throughout each quarter. Therefore, clients of advisors using DFA equity funds were NOT, as a whole, selling low and buying high.

Advisor Allocations to Dimensional Equity Funds
January 2008-September 2009
In USD (Billions)
Source: Morningstar Estimated Net Flows Open End Ex MM and FOF.

These two charts empirically show the outcome of the bear market on both "average" retail investors and DFA investors. Not only did the retail investor behave in a helter-skelter way, but you may notice that the massive sells during the worst quarters of the bear market were not fully re-bought when the market starting going up. Billions upon billions of dollars sold close to the bottom and are still not back in the market, even though asset classes returns have increased between 50% and 120% from their lows in March. DFA investors as a class have been in the market since the bottom and have enjoyed the steep upturn, and will undoubtedly become whole in much less time than the average retail investor.

Selling a properly diversified portfolio during a bear market is akin to jumping out of a frying pan into the fire. It is certain that the portfolio will not be able to efficiently grow back its capital in the next bull market, because they will be out of the market when the easiest money is made – during the first stages of the next bull. They are sure to get burned, if not totally fried.

As always, feel free to contact us with questions about this or any other topic. Enjoy your holidays.

DIXON HUGHES WEALTH ADVISORS