Go Slow, Don’t Panic

The dynamic between institutional and retail investors during market downturns offers some insight into the factors that impact market instability. A growing body of evidence suggests that the behavior of these two groups diverges meaningfully during times of significant financial stress.

Retail investors are often driven by fear and emotional biases. Studies show they have a propensity to engage in panic selling when markets experience sharp declines. This behavior was noticeable during the market pullback last August. Retail investors sold off $1 billion in equities, which was unusually high compared to their normal selling patterns over the prior year. As a result, retail sellers saw their portfolio performance decline more severely in 2024 than the broader market.

On the other hand, institutional investors demonstrated a more measured and opportunistic approach. As retail investors fled, institutions stepped in, buying $14 billion in stocks. This buying activity was unusually high compared to their normal buying patterns over the prior year.

The diverging behavior of retail and institutional investors during market downturns is not an isolated occurrence. Data has shown that during crisis periods such as the COVID-19 pandemic and the 2008-09 financial crisis, retail trading activity had a pronounced impact on market volatility.

The profitability of “buying the dip” can provide an ongoing boost to returns. However, the impact is not uniform across all assets. Institutional ownership levels, valuation metrics, and price-trend factors can affect any dip-buying strategy.

Historical data highlights the wisdom of the institutional approach. Since 1980, the S&P 500 has generated a median return of 6% in the three months following a 5% market decline 84% of the time. This suggests that the strategy of capitalizing on market corrections used by institutional investors tends to be more profitable over the long run.