Many investors too scared to take wing

The tantalizing climb in the stock market has made hedge fund and mutual fund managers increasingly courageous, but millions of investors with 401(k) accounts remain reluctant to trust what burned them.

That could hurt them, and the market as a whole.

Some individual investors clutched the money they had left after the market plunged more than 50 percent from October 2007 until March and stopped adding to stock funds. A recent study found about 6 percent stopped contributing to 401(k) plans altogether as they blamed workplace retirement savings plans, rather than the investments within the 401(k) plans, for losses.

“I am a middle-aged person, concerned about what approach is useful when it comes to socking away money for retirement,” said investor Ruth Lipman. “My previous strategy of putting as much money into my IRA, 401(k), as possible no longer seems prudent.”

Nonetheless, there are some signs that perhaps the fear is easing. When the Fidelity mutual fund firm dug through 11.2 million participant 401(k) accounts recently, researchers found that after three consecutive quarters of decreasing contributions, individuals increased them during the second quarter.

That might not be because of newfound confidence in the markets. It could be that with employment declining in the recession, people stopped saving for retirement temporarily while they paid down credit cards or set up emergency savings accounts and have begun to resume contributions.

The figures also could be skewed from a growing practice by employers to remove money from employee paychecks and automatically deposit it in workers’ 401(k) accounts.

Pamela Hess, a researcher at Hewitt Associates, sees no evidence that people are anxious to invest in stock funds again.

“People pulled back from stocks dramatically 1/8during the downturn], and we have not seen that reverse,” she said.

She finds that surprising, because usually investors chase stocks as they rise. This time, she thinks investors are traumatized. Their behavior is following what has been documented in academic research: That people are more motivated to avoid large losses than to seek large gains.

That could have ramifications for individuals and the stock market. For investors who pulled away from stocks or from contributing to their 401(k) plans completely, the possibility of building up enough money for retirement is threatened.

Hess said many investors were too exposed to the stock market prior to the downturn and consequently lost large sums. When they did not add to stock investments in the downturn, they reduced their chance of rebuilding money they had lost.

After sharp losses, financial planners encourage individuals to rebalance portfolios. That has them move money from safe investments like money market funds and put it into stock funds so that the money is positioned for eventual rallies.

“If they don’t, there is no way to get whole,” Hess said.

For the stock market to climb, reluctant investors will need to throw additional money into stocks and stock funds.

Many of the country’s largest mutual funds have less than 2 percent of their portfolios in cash. That means fund managers have little money to put into the stock market. And hedge funds have committed significant money to the stock market.

The value of the stock market, measured by the Wilshire 5000 index, is about $12.2 trillion, and individuals have $13.4 trillion in all retirement assets. So individuals’ decisions to choose stocks, bonds or other assets for nest eggs are important for the direction of the market.

This year, according to TrimTabs Investment Research, investors have poured an enormous amount of money into bond funds ? $208.4 billion. The flow into bond funds is on track to smash the annual record of $140.6 billion set in 2002, at the end of the last bear market.

This makes some investors think the market will surge once nervous investors start to hunger for stock market returns. But that won’t happen as long as people like Lipman recall the fear of 2007-09.

(c) 2009, Chicago Tribune. Source: McClatchy-Tribune Information Services.