On Wall Street, the institutional investors are referred to as the Smart Money and retail or individual investors are called the Dumb Money. While I don’t agree with Wall Street’s designation of institutional investors as being smart, it's difficult to argue against their view of retail investors.
Retail investors are called the Dumb Money mainly for the three reasons outlined below.
Chasing performance
It’s a well-known fact that the number one factor that mutual fund investors focus on is a mutual fund’s recent performance. This, of course is reinforced by all the ads the industry puts out to highlight their recent performance.
The marketing departments will make sure to put a spin on these ads and focus on whatever period they had success; it could be the past year, it could be their record the past 2, 5 or 10-year period, whatever looks good as long as it’s legal.
The problem that retail investors have when they pile their hard-earned cash in these funds is that they are buying high. Statistically, their chance of seeing the funds they’re buying going higher is very slim.
The reason is simple. The fund manager had some success (or luck) with a particular sector. As investors take notice of the short-term rise in the fund, they jump on the bandwagon. As the fund manager gets more cash, he needs to deploy the cash but the shares he’s buying now are no longer undervalued so in effect, he's buying high.
Emotions
In virtually all aspects of life, it’s never a good idea to act (or react) when you’re emotional. Think of that email you replied to at work and regretted it. Think of things you’ve said to someone you care about when you were in the middle of a fight.
When it comes to investing, it’s no different. The average investor consistently makes the wrong decision at precisely the wrong time by acting/reacting under emotions.
Time and time again, studies backed by decades of data show that the majority of investors will be heavily invested in equities when the market is most overvalued and at risk (i.e. at the height of a bull market - 2001, 2007).
And when the market is at its lowest point during a recession offering attractive valuations (i.e. at the lowest point of a bear market - 2003, 2009), the majority of investors will be on the sideline in cash or bonds.
The reason for this seemingly odd and costly behaviour? Greed and fear.
In a bull market where the market seems to be going up year after year, investors get greedy and jump on the bandwagon. They cannot resist the temptation when they hear people around them boast of making money.
In a bear market, all of a sudden, fear takes over and they cannot stand to see their portfolio drop in value. The media fuels this fear with sensational headlines such as: "$20 billion dollars in market value evaporates as the Dow Jones plummets 700 points in one day!"
Allure of fast money
There is something very appealing about the idea of making a lot of money with little or no effort. That's why there's never a shortage of people playing the lottery every week and this number even increases during recessions.
Investors are no different. They want a quick way to make money. That’s why they jump from one mutual fund to the next. That’s why they trade in and out of stocks. That’s why they fall for those services that offer trading tips on penny stocks.
The reason there is a Smart Money on Wall Street is because of the existence of the Dumb Money. In other words, the institutional investor will always be the predator and the individual investor will always be the prey.
Of course, if you refuse to play Wall Street’s game of chasing short-term gains and invest outside the jungle, you don’t have to worry about what goes on inside the jungle.
You can join the small but increasing number of astute investors who have realized that success in investing comes from having knowledge, patience, the right temperament and independent thinking.
Like them, you can transform yourself into this new breed of investors called the Intelligent Money.
Retail investors are called the Dumb Money mainly for the three reasons outlined below.
Chasing performance
It’s a well-known fact that the number one factor that mutual fund investors focus on is a mutual fund’s recent performance. This, of course is reinforced by all the ads the industry puts out to highlight their recent performance.
The problem that retail investors have when they pile their hard-earned cash in these funds is that they are buying high. Statistically, their chance of seeing the funds they’re buying going higher is very slim.
The reason is simple. The fund manager had some success (or luck) with a particular sector. As investors take notice of the short-term rise in the fund, they jump on the bandwagon. As the fund manager gets more cash, he needs to deploy the cash but the shares he’s buying now are no longer undervalued so in effect, he's buying high.
Emotions
In virtually all aspects of life, it’s never a good idea to act (or react) when you’re emotional. Think of that email you replied to at work and regretted it. Think of things you’ve said to someone you care about when you were in the middle of a fight.
When it comes to investing, it’s no different. The average investor consistently makes the wrong decision at precisely the wrong time by acting/reacting under emotions.
Time and time again, studies backed by decades of data show that the majority of investors will be heavily invested in equities when the market is most overvalued and at risk (i.e. at the height of a bull market - 2001, 2007).
And when the market is at its lowest point during a recession offering attractive valuations (i.e. at the lowest point of a bear market - 2003, 2009), the majority of investors will be on the sideline in cash or bonds.
The reason for this seemingly odd and costly behaviour? Greed and fear.
In a bull market where the market seems to be going up year after year, investors get greedy and jump on the bandwagon. They cannot resist the temptation when they hear people around them boast of making money.
In a bear market, all of a sudden, fear takes over and they cannot stand to see their portfolio drop in value. The media fuels this fear with sensational headlines such as: "$20 billion dollars in market value evaporates as the Dow Jones plummets 700 points in one day!"
Allure of fast money
There is something very appealing about the idea of making a lot of money with little or no effort. That's why there's never a shortage of people playing the lottery every week and this number even increases during recessions.
Investors are no different. They want a quick way to make money. That’s why they jump from one mutual fund to the next. That’s why they trade in and out of stocks. That’s why they fall for those services that offer trading tips on penny stocks.
The reason there is a Smart Money on Wall Street is because of the existence of the Dumb Money. In other words, the institutional investor will always be the predator and the individual investor will always be the prey.
Of course, if you refuse to play Wall Street’s game of chasing short-term gains and invest outside the jungle, you don’t have to worry about what goes on inside the jungle.
You can join the small but increasing number of astute investors who have realized that success in investing comes from having knowledge, patience, the right temperament and independent thinking.
Like them, you can transform yourself into this new breed of investors called the Intelligent Money.
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