Stay-the-Course Ahead of Panic Sellers

Rattled by the worst financial crisis since the Great Depression and a falling stock market, an atypical number of U.S. investors liquidated either some or all of their stock holdings during the latter part of 2008. During October 2008, the U.S. mutual fund industry saw more than $70 billion withdrawn from equity funds—the largest monthly outflow on record (see chart below).

Investors who stayed invested in a mix of stocks equivalent to the S&P 500^® Index after it fell to new lows amid the financial crisis in October 2008 would have been up about 9% one year later, and better off than investors who withdrew a record $70 billion from the market during October 2008 and remained out of stocks.

Familiar panic-selling costly for market timers
Using aggregate equity fund flow data as a gauge for the behavior of investors who attempted to move in and out of the stock market, the massive one-month outflow in October 2008 illustrates that a higher-than-average number of investors rushed out of stocks amid the market turmoil and financial system uncertainty.

However, investors who maintained their exposure to the stock market during October 2008—and were willing to weather the volatility that took place—were better off one year later for keeping their stock holdings compared to those who sold and remained out of stocks altogether.

At the end of the third quarter of 2009, the S&P 500 Index was 9% higher than its average monthly level in October 2008—a return that is roughly the average annual long-term advance for this benchmark throughout history.¹

What's more, during the five months after the unusually large monthly outflow seen during October 2008, investors liquidated another $83.5 billion from equity funds at even lower S&P 500 levels, including a two-month outflow of $52 billion in February and March of 2009—just prior to the market's sudden and rapid reversal (see chart above). As the market rebounded sharply over the next five months (April-to-August), money trickled back into equity funds. However, these inflows were only a fraction of the outflows seen during prior months. As a result, it's reasonable to assume that there was a greater-than-normal number of investors who either reduced their exposure or remained out of stocks near the March low point (or earlier), missing all of the market's abrupt turnaround. Further, many investors who had sold and chose to re-enter the market were buying back in at higher price levels.

Investment implications
An atypically large number of investors liquidated stock holdings at or below current price levels during the past year and failed to reinvest their capital in time to participate in the 2009 market rebound. The massive flows in and out of equity funds highlight the difficulty people have in trying to adequately time swings in market performance. Quite often, investors make emotionally charged portfolio adjustments that result in worse performance than if they simply had stayed invested.

Long-term investors should recall that the market periodically goes through boom and bust periods. Historically, riskier asset classes have provided higher returns relative to more conservative assets over time to compensate investors for the risk of tolerating a higher level of volatility. Thus, altering a well-thought-out allocation to stocks after a significant downturn may not be the best strategy for long-term capital.

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Investment decisions should be based on an individual's own goals, time horizon, and tolerance for risk.

Past performance is no guarantee of future results.

1. October 2008 average S&P 500 level: 969. September 30, 2009 S&P 500 level: 1,057. The long-term average annual S&P 500 Index total return from 1926-2009 is 9.8%, while the average annual price return for the same period is 5.4%. Index levels are generally quoted using price return indexes and do not include the returns from dividends. The 9% price return from average October 2008 levels through September 30, 2009 compares favorably with the long-term 9.8% total return and is well above the long-term average price return of 5.4%. Source: FactSet, Ibbotson, FMRCo (MARE) as of 9/30/09.

2. Portfolio Review is an educational tool offered for use by Fidelity Brokerage Services LLC, member NYSE, SIPC.

You cannot invest directly in an index.

The S&P 500^® Index, a market-capitalization-weighted index of common stocks, is a registered service mark of The McGraw-Hill Companies, Inc. and has been licensed for use by Fidelity Distributors Corporation. All indices are unmanaged and performance of the indices include reinvestment of dividends and interest income, unless otherwise noted, are not illustrative of any particular investment and an investment cannot be made in any index.

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