Many investors have fled from mutual funds, which now face uphill battles because the stock-pickers managing the funds are limited now in the bargain hunting they can do for cheap shares.
Traumatized investors have been fleeing mutual funds in huge numbers — grabbing what remains of their money and putting it anywhere that doesn’t leave a knot in their stomach.
The most dramatic lurch for the exits might be over, but history suggests people could be yanking money from mutual funds for years. Such a trend could hurt people who remain invested, as well as some who sold out.
After the 48 percent decline in the stock market in 1973 and 1974, people pulled money out of mutual funds until 1980, even though the market moved higher.
“They used the strength in the market to get out,” said Eric Bjorgen, who tracked the trend for the Leuthold Group, a Minneapolis-based research firm. “Many never came back into the market.” Bjorgen said.
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With the market plunging in October, many fled after losing nearly half of the money they’d had about a year earlier.
This year, investors have pulled roughly $200 billion out of U.S. and international stock mutual funds — a huge reversal from the $254 billion they poured into funds the previous two years, said David Santschi, TrimTabs managing editor.
Selling shares in losing funds can be smart for those planning to declare a loss on their taxes, many people have shifted money into low-interest savings accounts and money-market funds. Some have made costly mistakes, such as pulling money from 401(k) plans without realizing they owe taxes and penalties that could strip almost half of their savings.
Those staying in mutual funds probably will receive the advantage, eventually, of a stock-market surge. But some funds face an uphill battle because managers are limited now in their bargain hunting for cheap shares.
It’s a result of so many fleeing investors fleeing funds. When a person wants to leave a fund, it must have cash available to give the investor.
Most funds tend to hold little cash, and as investors sell shares, managers must raise cash to pay them by selling stocks they wouldn’t otherwise sell, said Morningstar analyst Karen Dolan.
“A fund facing redemptions is restricted in its flexibility to do much,” she said.
Selling shares that have potential to climb eliminates some opportunity for funds to make money when the stocks regain strength.
In addition, respected investors such as Warren Buffett contend bargains are plentiful now, but fund managers who are busy raising cash might not have money available to bargain-hunt. That will dampen the returns a fund can make in the future.
Big money can be made by picking solid stocks beaten down in bear markets. On average, in the first year after bear-market lows, the stock market climbs 44 percent, according to the Leuthold Group.
By the second year, on average, the market is up 60 percent from its lows.