Clients get spooked and confused when the stock market goes down. Although you would never use this analogy, there are more sellers than buyers. They might wonder what the sellers are doing with the money they pull out of stocks. They ask: “Where does the money go?”
There are many types of players in the stock market. You have day traders on one side and institutions with long time horizons on the other end. Here are a few reasons why regular people redeploy money that is pulled out of the stock market.
1. Asset reallocation. You probably have firsthand experience with this one. Your client has ridden the stock market up. You have recommended they lighten up on stocks because they are seriously overweighted thanks to appreciation over time. They said “No,” insisting they stick with a stock heavy portfolio. Now the market has changed direction. They have seen losses on their monthly statements. They decided to take your advice and lighten up on their overweighting of stocks. They are late, but at least they are following your advice.
2. Paying down margin debt. Imagine a three-masted sailing ship with all the sails unfurled. It can move very quickly when the wind is blowing in the right direction. Now imagine a hurricane, a big storm at sea. At this moment, the ship wants to present the smallest possible target. If all the sails were up, the ship would be pulled in many directions. The sails would tear, and the masts might break. Going into a volatile market with a high margin balance is a similar situation. The margin loan stays the same and grows with interest. All the pain is felt by the investor’s equity. The investor may be selling stock to reduce or eliminate the margin debt. If they got a maintenance call in a volatile market, they might need to sell stock at the worst possible moment.
3. Paying down high interest debt. Let us assume the investor is a normal American. According to bankrate.com, 35% of Americans carry over credit card debt month to month. According to wallethub.com, the average interest rate on existing accounts is 19.07%. How about home equity lines of credit (HELOC)? According to bankrate.com, as of 3/15/23, the average rate is 7.76%. The easiest way to “earn” 19% on your money is to stop paying 19% on an outstanding balance to the credit card company. Some people pull money of the stock market and get their personal finances into better shape by paying down high interest rate debt.
4. Buying short term bonds. This is also called going into cash or staying on the sidelines. According to the Investment Company Institute, as of 3/16/23, there was $5.01 trillion in money market fund assets. According to Forbes, as of 3/20/23, some money market account rates average between 3.40%–4.65%. Large institutions might buy Treasury bills directly. They may be waiting for Federal Reserve to stop raising interest rates and the stock market to turn around before getting back into stocks.
5. Into counter cyclical or defensive stocks. If the stock market is considered a predictor of where the economy will be several months in the future, some investors might take money out of the broad market and invest in areas that are not closely tied to economic cycles. Businesses that sell to the Federal government might be less sensitive because the government is always spending money. People always use electricity and buy food.
6. Into different sectors of the S&P 500. This answer might tie into the previous one, if clients are asking “What stocks are doing better?” The S&P 500 is comprised of 11 sectors. As of 3/17/23, the overall index is down 10.12% for the year. The energy sector is up 8.18% YTD. Consumer staples is down 2.06%. At the other extreme, the real estate sector is down 21.89%, consumer discretionary is down 20.52% and communications is down 19.54% followed by financials, down 19.50%. Some investors might assume the money coming out of one sector is flowing into another.
7. Into loans to others. The money might come out of the stock market because a family member lost their job or is in a tight spot because interest rates are rising and they owe a lot of money tied to a variable interest rate. There is an old saying, “Charity begins at home.”
8. Into alternative assets. There are many areas to choose from. You have heard people talk up precious metals, wine and fine art. According to Forbes, fine art has returned about 7.6% over time. The logic is that it isn’t tied to the stock market in terms of performance. These can be difficult markets for ordinary people to invest in, but some big investors might send money in this direction.
9. Out of the market, never to return. Another simple answer to “where does the money go?” is “as far away as possible.” Some investors have been scared out. They had less appetite for risk than they thought. Maybe there were not getting good advice or simply following the crowd.
It is important to realize for every seller, there is a buyer at that market.
Bryce Sanders is president of Perceptive Business Solutions Inc. He provides HNW client acquisition training for the financial services industry. His book Captivating the Wealthy Investor is available on Amazon.