Investors, Nostalgic For Logical Markets, Boycott New Centrally-Planned Normal

Tyler Durden's picture

One of the deepest mysteries related to the ongoing rally in U.S. equities is the persistent lack of retail investor involvement. QAs we have vociferously noted, U.S. equity mutual fund flows remain solidly negative and interest in single stock trading among individual investors is similarly moribund - while corporate bond volumes remain flat and Treasury volumes higher.  As Nick Colas, of ConvergEx group, notes, one missing link to explain this dichotomy must be the fundamental lack of financial literacy among U.S. retail investors, yet this relationship is seldom mentioned as a reason for this group’s ongoing apathy in the face of 4-year highs for domestic stocks.  The Securities and Exchange Commission’s recently released study of financial literacy among retail investors outlines just how little this group really knows about capital markets and highlights the underlying rationale behind many of their recent seemingly irrational behaviors.


Stock vs Corporate Bond vs Treasury trading volumes...

Nick Colas, ConvergEx: Retail Investors And Financial Literacy

If the U.S. equity market is such a good party, why is the dance floor so empty?  OK – that’s a bit of exaggeration, of course.  At the same time, it is hard to overlook declining volumes in stock trading or the persistent redemptions out of U.S. equity mutual funds.  A few points here:

  • The S&P 500 is up 14.3% year-to-date, but the funds dedicated to this asset class have yet to see a month where money flows are positive.
  • Over this year of above-trend performance, in fact, investors have redeemed just over $80 billion in assets from U.S. stock mutual funds, or $250 for every American man, woman and child.
  • Look further back, and this pattern hold true for the entire rally from the lows in March 2009.  American investors aren’t chasing performance; in fact, they are running from it.
  • A recent article on Bloomberg cited a 37% drop in trading volume on U.S. exchanges when comparing the first half of 2008 to the same period in 2012.  The August comparison, using data we compile at ConvergEx, shows that trading volumes for last month were down more like 45% from the same month in 2011.

While there are a host of reasons for the decline in U.S. volumes, the issue I would like to focus for the remainder of this note is retail investor knowledge and how this relates to their confidence in capital markets.  The connection between these two factors is straightforward: investors need more than a rising market to invest.  They need to feel that they understand it and enjoy some level of competence before they trade.  An academic paper, published in Management Science (Investor Competence, Trading Frequency, and Home Bias by Graham, Harvey and Huang, July 2009) performed a useful analysis defining this relationship.  A few points to summarize their work:

  • Using data from surveys conducted by UBS/Gallup, the researchers ranked retail investors by how “Competent” these market participants rated themselves at making their own investment decisions on a 1-5 scale.
  • Investors who ranked themselves as significantly more competent traded (4 or more on that 1-5 scale) much more frequently than those who ranked themselves lower.  Over half of this group traded at least once a month, versus 28% for the lower-ranked group, for example.
  • The research also established that men trade much more than women, with 43% trading once a month, versus just 25% for their female counterparts.  Relative youth also correlated with greater trading frequency, as did the level of household income.
  • Levels of educational achievement also correlate strongly with the frequency of trading.  A retail investor with a post-graduate degree trades stocks on a monthly basis much more frequently than one who did not finish college – 43% of the first group trades monthly, versus just 25% of the latter.

That last point, on education, got me wondering about how much U.S. retail investors really understand about modern capital markets.  As it happens, the U.S. Congress had a similar question in the wake of the Financial Crisis and asked the Securities and Exchange Commission to explore the topic as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.  Their study, released on August 30th, leverages a review of various literature on the topic done by the Library of Congress as well as the SEC’s own findings from focus groups and online surveys of retail investors.


The upshot of these analyses is bleak: “The studies demonstrate that investors have a weak grasp of elementary financial concepts and lack critical knowledge of ways to avoid investment fraud.”  Much of the +200 page SEC review is not actually about financial literacy, but rather describes how investors process information regarding financial disclosures in the face of this knowledge deficit.   The numerous direct quotes from survey and focus group respondents highlights that investors want simple, brief disclosures and explanations, despite their lack of understanding of how capital markets work.


The Library of Congress report, published in December 2011, contains even more chilling details about what U.S. investors actually know about capital markets.  The study, which reviews 8 different independent surveys, starts with a key finding of a 2009 FINRA report that “Americans lack basic financial literacy.”  The report includes the questions posed by the different surveys, a sample of which I include here, along with a few observations:

  • Question: If interest rates rise, what will typically happen to bond prices?  Only 21% of the 2009 FINRA National Financial Capability Study knew that the answer was “They will fall.”  The same question to a group of active U.S. military got only a 30% correct response rate.  In a 2010 Northwest Mutual survey, only 41% knew the relationship between interest rates and bond prices. This may go part of the way to explaining why fixed income products  - mutual funds and exchange traded funds, not to mention individual bonds – still enjoy strong money flows despite record low interest rates.  What happens to retail investor confidence in these investments when interest rates rise is, therefore, impossible to know.
  • Question: Buying a single company’s stock usually provides a safer return than a stock mutual fund?  Only 52% of respondents in the 2009 FINRA survey got this right, and a 2007 Moneytrak/IPT survey found that only 39% of respondents knew the definition of “Diversification.”
  • Question: What return would you expect from a broadly diversified U.S. stock mutual fund over the long term?  The “Correct” answer, according an SEC telephone survey held in 2008, is 10% and 53% of respondents answered as such.  Numerous other studies had similar questions about the long run potential of U.S. stocks and most respondents answered in the same vein.

Two points pop out from this line of questioning.  The first is that none of the surveys asked “How much volatility are you willing to stand in order to earn that 10%?”  That’s a critical variable, and it may well be that retail investors are anchoring their expectations of future volatility against the last 5 years.  Second, it might be the case that investors have downgraded their expectations of long-term returns with the paltry returns exhibited by stocks since 2000.

In summary, the data shows that retail investors do not generally have the knowledge necessary to make sense of modern capital markets.  Add the volatility of the Financial Crisis and the macro-policy driven stock markets of today, and you have a recipe for reduced confidence in their abilities to invest.  Against that backdrop, the asset moves out of stocks and into bonds makes sense.


You might argue that “It was always thus…” and that is a fair point.   American investors haven’t grown dumber on financial matters in the last decade; they never had the requisite knowledge to begin with.  But it does appear that the events of the last few years have caused some kind of “Tipping point” with regard to investors’ ability to process the world around them.  The only prescription to allay their concerns is, I think, time.  Time, and continued strong performance from U.S. stocks.

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Clint Liquor's picture

In summary, the data shows that retail investors do not generally have the knowledge necessary to make sense of modern capital markets. 

That's because 'Modern Capital Markets' don't make any sense. It's all manipulated and corrupt.

e-man's picture

...which is precisely the reason the government will need to convert your 401k/IRA to Treasurys. 

illyia's picture

Because they know that they will be the bag-holders (through some sort of hidden elite machinations) they stay out.

And, they are right. They are the greater fool, and they know it.

Richard Chesler's picture

What's left of my 401K to equity sell side douchebags: you can shove 'em up your ass.


James's picture

Unless and until they prosecute FRAUD the Street has lost retail forever.

Market only moves positive if 'nanke prints.

And that is the only reason their even is a market.

Remember, what the CME did to those farmers resonated everywhere.Not just the farmers.Gensler should be behind bars.

It won't happen but ALL of the familiar faces need to never be seen again.

Dimon called before the Senate and treated like a rock star.


Jefferson county, Alabama

Alot of that reported european bailout was infact VERY pissed off people w/worthless MBS being redeemed.Was I not supposed to know that?

Are these investors not supposed to question the strength of municipalities, pension investments,even whole States?

This whole country?

Congress front running stocks?

Sorry Nick but they not only killed the proverbial goose but chose to shit where they sleep.


Disclaimer-I am the shoeshine boy.These fuckers ruined what I did for over 30 yrs. I slam down oak flooring and gut kitchens for remodeling. Even I can see what's going on and I've never played the Market.Good luck w/that!

One more thing Nick, The money I used to use for cashflow is now being used to buy Silver. I don't give a damn what the "Market" does to my metal. Ben could crash it tommorrow and I'll just back the truck up for more metal. In a few years I won't have to worry about "reserve currency" because the U.S. won't be the reserve anyway. And 'nanke won't be dictating shit

To date there are 140 countries that want NOTHING to do w/BennyBux.Ohs nos, I was'nt supposed to know that either!

Maybe someother time we can go over P/E.

And you insinuate that my peers, some seasoned, are'nt smart enough for this oh so sophisticated "market"? PFFFFT


FreedomGuy's picture

Which makes them the lesser fool by avoiding the market all together.

Stoploss's picture

Ha ha, "markets this" markets that", markets, markets markets.

Markets have natural true price discovery mechanisms.

What markets..

wee-weed up's picture

There are no more "logical" markets. "They're ridin' dirty!" To use a quote from Obama's mentor and 20 yr pastor, Rev. Jeremiah Wright.

wee-weed up's picture

Of course, if you believe the MSM... in 20 years, Obama never heard a single word "God Damn America!" Wright ever said.

smlbizman's picture

thats the new louder drum beat...i even heard this woman say that even the pros arnt competent enough to make financial guess who is competent enough?...retail no, professional money same people who have managed our country so me its for your own good....


and as a second point, i was smart enough to trade and invest in this market for 25 years...than i got fucking stupid and over  a 2yr. period closed out the iras, paid the tolls and bought silver and gold...the real kind...yep i am a moron...

Slightly Insane's picture

Retail Investors not "jumping in"?   Disposable income shredded,  this thing called High Frequency Trading, which has been known to lead to "flash crash", and quite possibly "the deer in the headlights" response to the absurd criminal activities of the guberment and the Fed.  I'm not surprised, at all.

Snakeeyes's picture

Mortgage debt is declining and even credit cards are contacting. M2 Money velocity is the worse it has even been. Bernanke is out of ammo but stocks keep rising.

spinone's picture

People understand that the stock market looks like its going up, but if you put your money in there you'll lose it.

Clint Liquor's picture

Agreed. It's like a boy being invited to his second camping trip with Jerry Sandusky. Thanks, but I'll sit this one out. (pun intended)

g speed's picture

the age of the average investor and them not wanting to "gamble" may have some bearing here.

ebworthen's picture

Besides needing the money from being laid off or for medical bills or underwater mortgages the skullduggery of Wall Street has not escaped those who have a choice.

Most are perfectly happy with 1-2% in Treasuries or TIPS because they aren't subject to the stock slot machine equities, despite Jim Cramer and investment "advisers" who say you are crazy not to invest in dividend paying stocks.

It's either "give me the cash" or "give me government debt" because by the time the government defaults it will be after equities are six feet under (S&P below 666).

"Fool me once - shame on you.  Fool me twice - shame on me."

FreedomGuy's picture

Yeah, I held Pfizer stock as it dropped from high teens to $11 per share but the dividend was going to pay almost 11%. Then they cut the dividend in half and I dumped it. Jeff Kindler an Obama acolyte was the CEO. So, you can tell me all that dividend crap and I know under the right conditions...generally the very conditions where I woiuld want to own the stock, the rules will change against me without warning.

The problem is the game is rigged against the individual investor and things out of your control come in from nowhere. Even the stuff you see can throw you for a loop.  Something in the EU could drop the DOW a few thousand points in a week. Obama getting reelected will have an effect. The Fed rigs the interest rates. It is all out of your control. Add to that record sustained unemployment, underemployment and there is a general malaise that makes it hard to throw much into the market casino.

On the other hand, when I play the craps table in Vegas, I know very precisely what the odds of every play are. There are no pronouncements from the casino or crew at the table that change anything. There are no surprises. There is no Fed, prime minister or central banker screwing with the odds, the rules or the payouts. The casino does not change the dividend payment after someone hits a point.

The same people like me who will play the craps table where we know the odds are against us but the rules are concrete will not do much with the market where the rules and variables are against us.

Conrad Murray's picture

Modern Capital Markets:

Person A) I ain't got shit in the bitches. Gimmie that dollar or imma cut ya

Person B) I have no idea what I'm invested in. They take the money out of my check and I hope for the best.

Person C) I'm a super trading ninja with nightvision goggles and IBD. I own the markets. NO you can't see my P/L!

Squi D) That's right bitches, ya betta have my money.

Tippoo Sultan's picture

Persons A,B, and C/total portfolio return:

"Two in the hat.".


Meesohaawnee's picture

retail has long figured out this is a rigged fraud. Unlike 00 with the internet boom, there are many other resources to understand what REALLY is going on rather than being sold what corporate/fed owned bubble vision is telling you. The game is up yahoo finance, cnbs. Youve been exposed as just outsourced ad firms of the fed and corporate insiders. Thats why retail is gone and longer this joke goes on the more difficult it will be to get them back.

Sam Clemons's picture

Why does knowing anything about "modern" capital markets matter when the only thing that matters is whether or not we are creating more fiat money?

Dexter Morgan's picture

Absolutely true.  That is seriously the only thing that matters.

Dexter Morgan's picture

I just made the decision last week to cash out my trading account.  I was a frequent trader and even dabbled in futures for the last 6 months.  However, I no longer want The Morgue holding any of my wealth.  Call me crazy but I was 70% invested in precious metals and I took my paper from my trading account and bought more so I am 90% invested in physical precious metals now.  It was a hard decision at first because trading is fun, but after what I saw trading gold futures I don't want any part of their shystem anymore. 

Things that go bump's picture

Is he calling me stupid?  

Robslob's picture

I would say 2 crashes within a 10 Year period was a great start.

Most accepted the "bubble in tech" but none, including myself, even heard about the "run on the banks" in 2008 then couple that with "housing bubble bursting" which we all were implicitly taught from generation after generation could never EVER happen because a "home is an asset".

So they scared us out of stocks (congrats banwads) and then you scare us out housing AND THEN you scare us away from Banks period.

Well played Elites, Bankers, PoliSHITins and Thank You SCOTUS for selling the balance away...well played?




buzzsaw99's picture

People who don't want to play in wall street's kitty box are stupid? That's what this article boils down to? It sounds to me like they know very well how to avoid financial fraud since they are cashing out of the corrupt stock market.

Things that go bump's picture

They didn't expect to be left holding the bag.  Who is stupid now, Wall Street?

Bob's picture

WS had, and still has, implicit 401k and pension fund guarantees (sheer mass alone establishes a very, very firm floor for the well informed to scramble out on top of)  . . . of who will be holding the bag at the end. 

Fuk u, jo mdl cls. 

Hondo's picture

I know of many so called sofisticated investors haven't the knowledge either. They certainly can't add alpha and even delivering beta is had for them. Most are stck in the old world saying just stick with me and the old world will return

Schmuck Raker's picture

It surely has nothing to do with the average person's perception that everyone in the financial industry is crookeder than a Krazy Straw.


I think the fact investors are ignoring the market despite it's recent rise is proof of their intelligence. People who answer phone surveys are stupid, that's all.

obessoligarch's picture

indeed market is a mystery,only those bold enough can see it's course.people who answer phone surveys is having the stupid idea that theyr opinion counts.



asteroids's picture

No, it's simpler than that with 47million people on food stamps, and probably another 50million within shouting distance, and 150million with no hope of a reasonable reitirement, retail is BROKE!

A Lunatic's picture

It will be close but I believe the DHS can still double tap them all without blowing the ammo budget........

1C3-N1N3's picture

"41% knew the relationship between interest rates and bond prices."


10% knew the relationship, while 31% happened to guess correctly.

tickhound's picture

We're 'sophisticated' if we play... unknowledgeable idiots if we don't.

These SEC, etc, studies read more like propaganda.  The casino never cares how 'knowledgeable' its players are... ONLY that they keep playing.

Markets are meant to be confusing and retail investors should be confused... ITS THE POINT.  This isn't a 'problem' in our system, its a vital cog.

buzzsaw99's picture

top 10 reasons not to play:


1) your money could be corzined at any moment.

2) HFTs will screw you coming and going on every trade.

3) 1 in 3 of your investment dollars goes directly to insiders.

4) I be broke already bitchez.

5) the eCONoME is in the shitter.

6) the fed hates my ever living guts

7) price manipulation

8) corruption from the president on down

9) the securities and exchange farcemission

10) the shyster mercatile exchange

Umh's picture

I guess I'm just luckier than that.

Quaderratic Probing's picture

“The studies demonstrate that investors have a weak grasp of elementary financial concepts and lack critical knowledge of ways to avoid investment fraud.” 

Sounds like are avoiding fraud...

sosoome's picture

Whether or not one possesses a college degree, a skunk still smells like a skunk.

Racer's picture

When you are up against an uber fast high shooting HFT gunner you give up as a mere mortal..... you know you are out gunned and run for the hills

buzzsaw99's picture

he who cashes and runs away lives to eat another day

A Lunatic's picture

My algo understands this market just fine............

benbushiii's picture

How can a market go up with people heading for exits?  Manipulation through arbed buy programs and the FED’s S&P targeting!

ekm's picture

I didn't know education was required to play in the casino.

Does anybody know what is the average education level of Las Vegas casino players?


AurorusBorealus's picture

I can tell you what the average education of a poker player is... about the average for men in America.  Poker players come from all walks of life: mafiosos, drug-dealers, stock-brokers, doctors, delivery-truck drivers, plumbers, professional athletes, union electricians, college kids playing with loan money.  I can also tell you that formal education has little or no bearing on how well a man plays poker.  And poker is every bit as complex as any "financial analysis" or creating an investment strategy.  It's also not just smarts that makes a man good; it's a willingness to take risks tempered by caution at the first sign of danger.

Umh's picture

In every poker game I've been in there are 1 to 3 good players, 2 to 4 terrible players and the rest are just treading water which actually sounds like most investors that I've talked to.

roadsnbridges's picture

"fundamental lack of financial literacy"

We know it's rigged, well, except for my neighbor who has been in for 30yrs just for the dividends.

He doesn't care about the price as long as those divis keep rolling in.  He's now 87.

endicott glacier's picture

Hmm! that logic does not cut it and not fair to retail investor. Even though a layman may not understand the physics/mechanics of what happens when he/she jumps from the 100th floor to the ground they would know it is bad for them and would not do it based on seeing the consequences in evening news or past experiences of others. It would be incorrect to conlude that he/she is not jumping because they did not understand the physical phenomeon that takes place after the jump. Its a learned behavior, they have seen what wall street has done, have no confidence in it, and just avoid it.