Many investors choose to purchase mutual funds instead of buying individual stocks. There is good reason for this as mutual funds provide the benefits of diversification. Owning a basket of securities instead of an individual security exposes the investor to far less individual stock risk. However, that does not mean mutual funds are risk free; it remains that mutual funds carry normal market risk.
As the market has performed fairly poorly this year, many mutual funds have posted losses throughout 2015. After all, the S&P 500 Index is down 4% year-to-date. This will inevitably bring down many mutual fund classes along with it, and after including fees and expenses, performance of many mutual funds may disappoint investors.
However, there is still an argument to be made for sticking with high-quality mutual funds, and the market in general.
Investors Losing Their Appetite for Equity Mutual Funds
One of the ways an investor can decipher the state of the mutual fund industry is through fund flows. This is a metric that analyzes whether investors are putting money into, or taking money out of, mutual funds over the course of a year. While there have been brief periods of inflows, for the most part mutual funds have sustained net outflows throughout 2015. For example, investors withdrew $18.9 billion from active U.S. mutual funds in May, the biggest outflow rate since July 2011.
Flows have trended downward more recently as well. In September, equity funds posted outflows in three out of the four weeks. Equity fund outflows totaled $19.1 billion while inflows totaled $12.7 billion, according to Lipper. That equates to a net outflow of $6.4 billion.
Of course, this is no surprise given fund flows tend to track the performance of the broader market in general. As the market has declined this year, investors have taken money out of mutual funds, using them as a source of funds and a means to reduce exposure to the perception of future market declines. The equity market had enjoyed a six-year, virtually uninterrupted rise since the financial crisis. At some point, volatility was bound to return.
Bond Mutual Funds Reap the Benefits
Worries over slowing global economic growth, particularly in emerging markets like China, was the key catalyst that started the sell-off. One of the biggest beneficiaries of the decline in stock markets and outflows from equity mutual funds is bond mutual funds. The U.S. Federal Reserve’s decision to delay raising interest rates for the first time since 2006 has allowed bonds to register solid gains this year, and bond mutual funds have naturally gained as well.
For example, taxable bonds and municipal bonds have posted decent across-the-board gains in the third quarter, and longer-duration bonds outperformed intermediate-term bonds. This is because bond prices increase when yields decline since price and yield are inversely related.
The Bottom Line
Individual investors may be disappointed to see markets decline this year, but it is important to remember that it is best to stick with long-term investment plans rather than bailing out of the markets at the first sign of trouble. Retail investors tend to sell after markets decline, only to buy in later when markets recover. This is a bad practice that will result in disappointing returns over time. After all, selling an asset at a low price and then buying it later at a higher price will cost an investor down the road.
For investors with a long-term time horizon, it makes sense to use market downturns to add to mutual funds since those funds can be purchased at more attractive prices.
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