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Investors Leaving Stocks For Bonds – Why Shouldn’t They?

16 August 2012 in Hardeep's Thoughts

A recent offer seen on Groupon a couple of days ago was selling a “four-day online stock-trading course,” with an original value of $1,500, for only $49. What a bargain, right?

In reality, this seems like the perfect metaphor for the amount of interest that the average retail investor is showing in stocks these days – that is, not a lot.

The numbers speak for themselves. In 21 of the past 23 weeks, US stock mutual funds have seen more money going out than coming in, including in a recent week reported (the week ended Aug. 1), when investors pulled $5.7 billion out stock funds – the highest total in 10 weeks.

Just as significant: according to the Zero Hedge blog, the four-day period of Aug. 6-9 saw the lowest stock trading volume in a non-Christmas week in five years!

The cruel irony for investors, of course, is that this collective retreat from equities has coincided with a substantial run-up in the market – since the S&P 500 hit an intraday low of 1266 on June 4, stocks have jumped more than 10%.

However, that rally was preceded by a two-month drop in stocks of about 11%.  That’s right – this latest market “surge” would have needed a 12.1% return to to bring equities to the same level they occupied more than four months ago.

I’ve been a vocal opponent of the current state of affairs in the investment industry – and how the everyday investor hasn’t been well served by it. But I also give investors credit that they know a tough stock market when they see one.  The continuing fiscal crisis in Europe combined with persistent high unemployment and sluggish corporate growth forecasts coming out of the US may have caused many investors to look for cover. 

And if your portfolio had seen no capital appreciation in the past four-and-a-half months, wouldn’t you start thinking about putting your money somewhere else?

That’s what is happening now – while stock funds are bleeding money, investors have decided that fixed-income is the way to go. As the New York Times’ Andrew Ross Sorkin recently noted, about $208 billion has flowed into the bond market in the past 12 months, according to the Investment Company Institute – including $5.1 billion in the week ended Aug. 1.

For many investors making their first foray into bonds, however, the transition can be challenging – and that includes the paltry 1.6% yield that 10-year Treasury notes are offering. It can be difficult for stock-based investors to embrace the idea that low-single-digit returns are desirable, but you can’t work at building capital if you don’t preserve it.

Investors then have to choose among actual bonds, bond funds or bond ETFs. They each have their advantages, but for everyday investors more familiar with stocks, I believe ETFs are probably the easiest to comprehend – the biggest of them are very liquid and, more importantly, they can help avoid a large minimum-investment amount often required by investing directly in bonds.

Although bonds may be having their day, I also don’t believe in the “death of equities” meme that has been making the rounds in some financial media outlets. When individual investors as a whole sense economic growth is returning, I would expect they will smartly return toward the vehicle – stocks – that can  capture that growth.

It’s worth noting that hybrid mutual funds, which invest in both stocks and bonds, had inflows of $630 million last week. As always, investors are best served by having a solid investment strategy that takes into consideration their risk tolerances and, generally avoids either extreme in the stocks and bond camps.

 — Hardeep Walia is co-founder and CEO of Motif Investing.