Dear Retail Investor,
Yes, that's you. Oh sure, you might not identify yourself as one. Despite your less than awe-inspiring wealth, perhaps you see yourself as an apprentice Warren Buffett or a nimble hedge-fund manager who merely lacks the hedge fund.
But if you manage your own money and your asset base has not yet attracted the attention of the Securities and Exchange Commission, you are a retail investor – and you should know what people are saying about you.
There's no way of sugar-coating this: The professionals look down upon you. No, it's true. They think you're a chump, buying high and selling low, rushing into every fad (with disastrous consequences) and generally doing everything too late. In two words: Dumb money.
However, the pros also believe you serve a useful purpose: You offer a valuable indicator of market sentiment – and gauging that sentiment has grown particularly important now that the bull market in stocks has entered its fifth year, and no one is sure where the market is going next.
To that end, the pros are looking closely for clues as to when they should exit.
"It has long been market folklore that the best time to buy stocks is when individual investors are bearish, and the best time to sell is when individual investors are bullish," said Robert Neal, a finance professor at the Kelley School of Business in Indiana, in a study on investor sentiment.
In an interview, he offered some theories as to why this is: "We trade too much, we're too aggressive, we're too optimistic, we think we know too much," he said.
Sentiment isn't always easy to measure, so the pros like to look at the weekly survey from the American Association of Individual Investors, which measures the percentage of investors who are bullish and bearish.
They also like to look at mutual fund flows, which can reflect bullishness when money is flowing into equity funds and bearishness when it is flowing out.
Right now, neither sentiment indicator is flashing a warning sign, but that just increases the pros' scrutiny of you. Are you feeling bullish now?
If all this makes you feel like surrendering your money to the hands of a pro, relax. There is another way: Don't be a typical retail investor.
This doesn't require research teams and a few billion dollars in assets. In fact, being a non-retail retail investor is surprisingly simple.
First, ignore the herd. Retail investors get into trouble because they like to follow the market. They love stocks when they're expensive and bull markets are in full swing, and loathe stocks when they're cheap and the bear is growling. Do the opposite: As the saying goes, buy when there is blood in the streets.
Second, accept that you are not Mr. Buffett. Over-confident investors get themselves into trouble because they take on too much risk in the hope of scoring spectacular gains. Instead, diversify and aim for the unspectacular, perhaps with low-cost exchange-traded funds that track a basket of stocks.
Third, think long-term. Retail investors are prone to expect their investments to pay off in a big way immediately – and when they don't, these investors switch tactics, often with dismal results.
Lastly, keep an eye on what retail investors are doing. They're chumps. And you're not.