Visual proof that investors are bad at timing the market

Because we used the inflows & outflows of a couple large retail mutual funds as proxy for investor demand, you're right that the story actually is "retail investors are bad at timing the market".

There's a whole other set of data to dive into whether or not professional managers as a whole are bad at market timing (spoiler: they are terrible at it), but you're right in that this is not what this data set addresses.

Really the point the article is making is that on the whole, you and I, the investing public, shouldn't try to "read the tea leaves" and pull our money in and out of the market / move money around in the market because of what we believe will happen in the near future. What this data proves is that this doesn't actually work.

You're right that the article should have been more clear - it's looking at retail investors specifically (in your example; Person2), which is the audience that FutureAdvisor focuses on. It's not focused on other actors in the market such as Institutional Investors, Hedge Funds, etc (you could see those other actors as Person1 and Person3, in your example). You are completely right that if you don't look at the market from any individual perspective there is no inflow and outflow, especially if keeping money in cash is still counted as "in the market".

If we say Person2 is the aggregate of all retail investors, then you have money flow. Person2 in your example has a $100 outflow from Equities and a $100 inflow to Tbonds.

The reason we chose to focus on retail investors and look at money flow from their perspective is to focus on a phenomenon that we see among individual investors, that of moving their money around in the market based on perceptions of the near future, and showing that the data shows this doesn't work.

Good question. The inflow/outflow data is from the ICI (Investment Company Institute - a consortium of fund companies) and is dollars in/out which is independent of asset performance.

I believe this is testing a false premise. The premise is, that when investors think the market is going to go up in the next month, they move money into mutual funds, and that when investors think the market is going to go down in the next month, they move money out.

I'm sure some proportion of investors move money in and out of mutual funds based on their market expectations, but I do not believe they do so with a single months time horizon, nor do I believe they are the majority.

I submit that a potentially quite large proportion of investors-- especially in mutual funds-- are not doing this, but are instead moving money into those mutual funds each month as a percentage of their paycheck goes into their 401k or into their savings plan. Further, some large proportion is likely investors moving from one mutual fund to another, while others are cashing out because they retire, etc. I bet a check on your flow dates to see if its correlated with an annual peak in employment change dates (e.g.: what month are people most likely to retire, or change jobs?) might find some correlation.

Worse, if I'm reading it correctly, this plot shows the return of the asset class over the course of a single month.

This means that you're assuming that these mutual fund investors are trying to time the market on the scale of the expected return within a month. This seems implausible to me given that mutual funds are managed and thus not well suited for timing (a lot easier to time the earnings announcement of Google, for instance, than guess what moves a mutual fund manager is going to make in a particular month.)

I suspect that most investors who choose mutual funds have at least a years time horizon, if not 5 years or more.

I realize that I didn't explain this part fully. Any asset aside from cash is speculative - and is primarily determined by how much a person's willing to buy and sell it for.

So when AAPL is worth 500 billion or whatever in one day, it doesn't actually mean that AAPL can be converted into cash wholesale for $500 billion dollars - it means that for that particular day, the small percentage of trading involving AAPL shares determined that people were willing to pay for XX amount of dollar/share for the stock and multiply that by number of outstanding shares => we get the market's valuation of AAPL at that particular moment of the market's condition of supply and demand. However, in the hypothetical scenario in which Steve Jobs foundation owned 100% of AAPL and decided to have estate-sale, the market dynamics of dumping all shares of a stock onto the market is equivalent of oversupply of the stock to sell and not enough buyers, and therefore driving the stock price down.

So suppose in the "flight to safety" scenario, the equity market is shaky for whatever reason: unrest in middle east, euro crisis etc. The demand for equity is less, therefore what I paid originally for SPY (S&P500 tracking index) may be $100, but the highest someone who wants to buy it from me might be $80. But I sell it anyways because I'm driven by fear that the market's going to deteriorate further. With that money, I have only $80 worth of buying-power.

On the flip-side, as everyone's getting out of the equity market, they rush to the government bonds market as this is the safest investment. The demand for treasury bills suddenly goes up, therefore to buy your bonds; you have to be willing to buy them at a higher price than the next guy. So if I want to buy the same number of bonds previously of value $100, I have to spend now $120. So you see how now the bond market taken at wholesale is valued more.

So in your scenario, flight of safety goes like this:

Person 2: Sells equity of original value of $100 for $80 to person1

Person 1: Then has equity valued at $80 at the time

Person 2: Buys $80 worth of bonds from person 3 and now has Tbond worth $80

Person 3: Sells bonds of original value of $100 for $120; a portion of which goes to person 2