S&P 500 vs. Investors – Are Retail Investors Really the “Dumb Money?”

Retail investors have many choices to buy and sell stocks: Mutual funds and ETFs are just two of them. Regardless of the options, investors are often considered the “dumb money.” Is the dumb money really dumb?

Wall Street geniuses and the financial media often consider retail investors the “dumb money.” That’s ironic, because Wall Street and the media are notorious for dishing out group think advice that’s getting many of the small guys burned.

There’s plenty of data that shows that a plain index investing or index ETF investing approach (the real “dumb” buy and hold a basket of stocks approach) handily beats the returns achieved by Ivy League educated mutual fund managers that engage in actively buying and selling.

If you’ve read my articles before you know that I like to pick on Wall Street and the financial media, but today we’ll talk about the investing prowess of retail investors – the “dumb money.” Is the dumb money really dumb?

Is the Dumb Money Really Dumb?

One of the best measures of retail investor’s appetite for stock is the asset allocation poll conducted by the American Association for Individual Investors (AAII).

The chart below plots the S&P 500 Index (SPY) against investors’ portfolio allocation to stocks. Investors’ stock allocation pretty much waxes and wanes with the performance of the S&P and almost plots a mirror image of the S&P.

Unfortunately, the cliché is true; retail investors buy when stocks are high and sell when stocks are low. I believe this is due to crowd behavior and the forces of investing peer pressure rather than stupidity, as the term dumb money implies.

What else can we learn from this chart aside from the fact that retail investors tend to buy high and sell low?

The average allocation to stocks since the inception of the survey in 1987 is 60.9% (dashed red line). The S&P currently trades near a 52-month high, yet investors’ allocation to stocks is below average (60.5% as of August). This is unusual.

In fact, in the 21st century there’ve only been a couple of instances where investors’ stock allocation was below average when the S&P was near a 3+ year high. Those instances are marked with a red arrow. In August 2006 stocks went on to rally. In March 2012 stocks declined first and rallied later.

Lessons Learned

The lesson for investors is A) not to follow the crowd and B) not to follow Wall Street or the financial media.

The mission of the Profit Radar Report is to keep investors on the right side of the trade. A composition of indicators used identified the March 2009 and October 2011 lows as investable lows and got investors out of stocks at the 2010, 2011, and 2012 highs.

Simon Maierhofer shares his market analysis and points out high probability, low risk buy/sell recommendations via the Profit Radar Report. Click here for a free trial to Simon’s Profit Radar Report.

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2 comments on “S&P 500 vs. Investors – Are Retail Investors Really the “Dumb Money?”

  1. TT says:

    Simon. I’m missing something. Bernanke just talked about how bad the economy is and why he needs to do QE to infinity at least to year 2014 and yet the people cheer and drive up the stock market. Are earnings going to soar? Is unemployment suddenly going to drop to 7%? People must think Bernanke doesn’t know what’s going on and with the great economy, he’ll push it forward with more cash. How can QE keep raising the stock market if the economy keeps falling? I’m befuddled! That financial cliff is coming. No one sees it?

  2. I agree TT, the more people think QE3 is making the stock market invincible the more dangerous it becomes. More and more corporations are announcing stock buy-backs (Nike $8 billion) while corporate insider selling outpaces buying by a 3 or 4 to 1 margin. Something doesn’t add up … that’s why the market needs the Bernanke put.

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