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The Risk of Record Stock Mutual Fund Redemptions

By on August 22, 2013 in Money

The Risk of Record Stock Mutual Fund RedemptionsApril was an interesting month for mutual fund investors around the globe. Fear in the markets about crisis in Europe and various other issues caused stock mutual fund redemptions to reach a level they haven’t seen in 17 years. But what is a stock fund redemption, and what does it really tell us about the markets?

What are Net Stock Fund Redemptions?

The term “net stock fund redemptions” means the overall inflow and outflow of investor money to a mutual fund is on the outflow side of the equation. There is more money being pulled out of stock mutual funds by investors than is being put in. If more money was being invested than withdrawn the term would be “net stock fund investment” or “net stock fund inflows”.

In short, investors are yanking money out of stock funds rather than investing in them for the future.

Why Are Investors Pulling Money Out of Stocks?

Global investors are scared about a multitude of factors: the European Union and Greek crisis, the lackluster performance of stock funds over the last decade or so, and the recent rise in equity prices from the crushing lows of a few years ago. Investors are seeking the security of less volatile investments like bonds and government issued debt.

Are Bonds a Better Investment Than Stocks Now?

Investors pulled out around $18.6 billion from equity funds in April. Much of that money was moved to investments that are seen to be less volatile like bond mutual funds. The only problem with this strategy is bonds may not be nearly as safe as some investors make them out to be.

It is true that bonds traditionally fluctuate less often than stock funds, but based on the current investment environment they may be set for some dramatic losses of their own. With interest rates being kept at historic lows by central banks, the price of bonds only has one direction to head in the long term: down.

Why are bonds doomed to drop in value? Bond values work inversely to interest rates. If interest rates rise – which, eventually, they must – then bond values fall. Likewise if interest rates drop then bond values increase. With current rates near 0% from an economic standpoint, they only have one direction to head and it isn’t a direction that favors bond investors.

To Be Fearful or Greedy?

The outflow of investor cash from stock mutual funds is an example of the classic issue with investing. Do you go with the crowd and rush out when everyone else rushes out? Or do you take a contrarian approach and rush in when the markets are running the other direction?

It can take quite the investment fortitude to be contrarian, but some of the greatest investors such as Benjamin Graham and Warren Buffett have excelled at it. Buffett’s famous quote of “[investors] should try to be fearful when others are greedy and greedy when others are fearful.”

With the markets running away from stocks and toward bonds, which way are you running?

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