Dumb money effect

The dumb money effect is the tendency of those investments chosen by dumb money (which largely means small private investors) to under-perform those chosen by smart money.

One of the most interesting pieces of research focuses on the flow of money into, and out or, mutual funds in the US. It showed that the funds into which investors put money were likely to under-perform relative to those from which they withdrew money.

Apart from the obvious lesson (do not keep switching funds trying to chase short term returns), it also suggests that investors can use the flow of money into and out of funds as a useful contrarian indicator.

Although it is common to characterise private investors as Dumb money and institutions as smart money, this is too simplistic. The average fund manager does not out-perform either, while a few individuals do become rich through successful investing.

Copyright © 2005-2016