By JACK HOUGH
Investors continue to pull more money out of stock mutual funds than they are putting in. Should you join them?
Net outflows were $3.2 billion for the week ended Aug. 15, according to data released Wednesday by the Investment Company Institute, a fund-industry trade group. Outflows have exceed $400 billion over the past five years.
One way to interpret the flow data is that, after 30 years of Treasury bonds offering better total returns than U.S. stocks, "the cult of equity is dying," to borrow a phrase from bond king Bill Gross's August investment outlook. If investors are losing their appetite for stocks, maybe it is time to take profits.
Then again, the Standard & Poor's 500-stock index's 13% total return so far this year hardly suggests stocks have lost their shine. Maybe the outflows mean the famously dumb herd is getting it wrong again, and that more handsome returns are in store for stocks.
Which reading is right? Neither, for two reasons -- one of which points to some important actions investors should take.
The first reason is that it is far from clear that mutual-fund flows predict stock-market returns.
During periods where the two measures seem to track each other, it seems more likely that investors chase stock-market returns rather than the other way around, says Brian Boyer, a visiting finance professor at the University of California, Los Angeles, who examined more than a half-century of fund flows and returns for a paper published in the Journal of Empirical Finance in 2009.
In other words, investors who are trying to read the market's next move in fund flows might as well be asking a Magic 8 Ball.
Investors Aren't Fleeing
The second reason is that a close look at the flows suggests investors aren't exactly fleeing stocks now.
For one thing, net outflows are tiny relative to the amount of money investors have in stock funds -- less than one-half of 1% this year, says Matthew Lemieux, an analyst at data firm Lipper.
Also, while investors have pulled money out of stock mutual funds this year, they have added an even greater amount to stock exchange-traded funds, according to Lipper.
That isn't quite the death of equities, but it is a serious maiming of equity fees. ETFs tend to passively track indexes and carry lower costs than actively managed mutual funds, says Todd Rosenbluth, a mutual-fund analyst at S&P Capital IQ.
As for the larger outflows of the past five years, they partly are explained by the baby boomers beginning to turn 65 last year, says Shelly Antoniewicz, an economist at the Investment Company Institute. Investors typically sell some stocks and buy more bonds in retirement because the latter are generally less prone to sharp price swings.
The outflows also are a reasonable response to the stock plunge that hit bottom in March 2009, Ms. Antoniewicz says.
ICI research shows that fewer investors are going all-in on stocks these days, and more are seeking diversification. Money is flowing into bond funds and into hybrid funds that invest in both stocks and bonds.
Flows also are positive this year for funds that hold non-U.S. stocks. That seems more a sensible rebalancing of positions than return-chasing. U.S. shares have gained 20.4% over the past year, versus 1.7% for shares in the rest of the world, according to index publisher MSCI.
Come to think of it, the herd hasn't looked so dumb lately.
Take the move to ETFs. On average over the past decade, 57% of active fund managers failed to beat their benchmark indexes after fees, according to S&P. Last year, 84% underperformed.
With mutual funds, you don't get what you pay for. Rather, what you pay comes directly out of what you get. So pay less. This column has long recommended low-cost mutual funds and ETFs from Vanguard Group, Charles Schwab (SCHW)
Investors who haven't rebalanced their portfolios lately should consider following the herd. The easiest way to get global diversification is with an all-world ETF like Vanguard Total World Stock (VT),
A cheaper route -- and one that allows for more U.S. exposure for those who want it -- is to use two separate funds and rebalance them from time to time. For example, Vanguard Total Stock Market (VTI)
For a bond ETF, SPDR Barclays Capital Aggregate Bond (LAG)
To figure out how much to put in stocks versus bonds, either pay a financial planner to tell you or search online for "Vanguard portfolio allocation models" to see how nine different mixes of stocks and bonds have historically performed.
The past 30 years aside, stock-heavy portfolios have generally provided higher long-term returns, but also deeper single-year declines.
The three "balanced" portfolios Vanguard recommends call for mixes of 60/40, 50/50 and 40/60. If you aren't sure, one of those is a good place to start.—Jack Hough is a columnist at SmartMoney.com. Email: email@example.com