Investors take the money and run

Published Sept. 3, 1999|Updated Sept. 29, 2005

Those itching to spend are cashing out of their mutual funds; redemption rates are at their highest level since '87.

Lately, a lot of investors have found one of the best things about mutual funds is selling them.

Don Matsanoff, 37, a commercial real estate broker in Columbus, Ohio, cashed out of a Dreyfus mutual fund in July and spent $24,000 of the proceeds on a sport utility vehicle. After enjoying strong returns for much of the '90s, he said, it was time to buy some things he had put off while he let his profits ride.

Most of his money remains in the market, he said, but he would rather take a profit on some of it "and use it for something than have it sit there and watch it go up and down."

Another Columbus real estate broker, Wayne Harer, 47, recently sold about $150,000 in fund shares to pay for home remodeling.

Amid the market's record highs and volatile moves, many investors have decided to sell some of their funds and use the profit to remodel the bathroom, buy a new washing machine, take that expensive vacation or splurge in some way.

In fact, investors are cashing out stock mutual fund shares at the highest rate in almost a dozen years. Though more money is still flowing into funds than is being taken out, the pace at which people have been selling fund shares has been growing faster than the rate of purchases.

This selling helps to explain the surge in consumer spending on big-ticket items. Home sales have soared, car sales are on pace to set a record, and retail sales have been very strong. By the way the federal government measures things, consumers are spending more than they earn.

Investors typically sell 13 to 17 percent of their stock mutual fund shares in any given year. But that rate has grown substantially, and in July investors redeemed shares from fund companies at an annual rate of 21.8 percent, according to figures released Monday by the Investment Company Institute, a trade group based in Washington. That is the highest level since December 1987, when investors were pulling money out in the aftermath of the October crash.

Of course, the fund redemptions are not all being spent on consumer goods. Some proceeds are being reinvested into other funds, or perhaps into Internet stocks or other market darlings. But economists and fund-company executives say those cannot account for the strong pace of redemptions lately.

Many economists say the giant profits earned in stock portfolios this decade have led individuals to spend far more than they otherwise would, thus helping keep the economy _ and corporate profits _ perking along. They break the "wealth effect" down like this: For every $100 increase in net worth, a consumer will spend an additional $3 or $4 a year.

With the recent increases in stock prices, that has translated into big spending gains. Total personal financial assets were $27.6-trillion as of March, nearly double the level at the end of 1992, according to the Federal Reserve. That does not count gains in home prices. Borrowings against increased home values "influence consumer outlays beyond the effects of gains from financial assets," Federal Reserve chairman Alan Greenspan said last week, adding that run-ups in the prices of homes are at least partly related to increases in stock prices.

The growing importance of investment gains means that central bankers "no longer have the luxury to look primarily to the flow of goods and services, as conventionally estimated, when evaluating the macroeconomic environment," Greenspan said. In other words, central bankers must increasingly wrestle with the value of consumers' stock portfolios, homes and personal debts when setting interest rates.

Though economists agree that investment gains play a large role in consumer spending, they still differ on the significance. A recent study by two officials at the Federal Reserve Bank of New York, for example, concluded that stock market fluctuations affect current spending, but "changes in wealth in this quarter do not portend significant changes in consumption one or more quarters later."

The high rate of mutual fund withdrawals suggests that consumers have been selling investments at a quick pace to maintain and upgrade their standard of living. Whether those sales continue, especially if the market swoons, could have big implications for the economy.

A. Michael Lipper, chairman of the fund research company Lipper Inc. in Summit, N.J., attributes some of the selling to the aging population. "A fair amount is due to people achieving their retirement and resetting their financial" goals, he said. "People are getting older."

But he also says that many others think the market may be overvalued. "They are reducing their equity commitment," Lipper said.

The high rate of fund redemptions unnerves John Brennan, chief executive of the Vanguard Group, who says he cannot figure why redemption rates would be higher now than during the market's nearly 20 percent sell-off a year ago. "That's the mysterious issue now," he said. "People who hung in last year are paring back and taking some risk off the table."

Investor optimism about the stock market has dropped sharply, according to a PaineWebber Inc. poll of small investors. Optimism is close to the lowest level in three years, with 55 percent of the people surveyed optimistic and 18 percent pessimistic, according to the poll, which was conducted by the Gallup Organization. The sample included 1,004 people with at least $10,000 in assets to invest. When asked what they thought the market would do in the next three months, 28 percent predicted it would rise and 23 percent said it would fall.

A lot more money is flowing into stock mutual funds than out, buoyed by stable streams of contributions to 401(k) plans, Individual Retirement Accounts and other such plans, which workers continue to sock away monthly to get tax breaks. After a rocky period following the market's drop a year ago, net fund sales are strong, if somewhat below the pace of the last two years. By this measure _ investor purchases minus redemptions _ investors poured $61.3-billion into stock funds in the second quarter and an additional $12.3-billion in July, according to the Investment Company Institute.

As the popularity of mutual-fund "supermarkets" like Charles Schwab & Co. has grown, some redemptions have gone into other mutual funds, though economists say they doubt this accounts for much of the rise in recent months.

"Supermarkets have been around awhile" and can account for only a small part of the sudden increase in stock fund redemptions, said John Rea, the chief economist of the Investment Company Institute. Moreover, investor switching within the same fund families has stayed at about the same pace, as a percentage of total fund assets, for a half-dozen years by the trade group's tally.

Some money from some redemptions is going into other investments, including stocks, as investors take advantage of low commissions available through online trading. In fact, the longstanding trend of investors selling shares of individual stocks slowed in the first quarter after having risen sharply for many years, according to data from the Federal Reserve.

Matsanoff, for example, the commercial real estate broker from Columbus, has transferred some money from funds to individual stocks in hopes of getting better returns. The fund he sold last month was performing well. "But my individual stocks were performing better," he said. "So when I decided which one I should pick in order to write a check for the truck, I thought my mutual fund was the way to go."

Although consumer debt levels and personal bankruptcies remain high, many consumers have paid down debt recently or chosen to pay for new purchases with cash rather than credit _ a trend also attributed in part to the strong stock market. In a recent report, Moody's Investors Service said that in the second quarter consumers paid off the highest percentage of their credit card debt in a decade and that credit card delinquency rates fell in June to their lowest monthly level since April 1996.