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Play-it-safe investors missing out on stock fund growth

July 08, 2007|Tom Petruno

IN the investment world, lessons sometimes can be learned too well.

Burned by the stock market's plunge of 2000 to 2002, many individual investors have since stuck with a conservative portfolio strategy.

Now, after 4 1/2 years of rising share prices, some people ought to be wondering whether they've been too conservative for their own good.

The cautious mood that has marked this decade shows up in small investors' approach to mutual funds.

U.S. stock market indexes hit or neared record highs in the first half of this year, but they did so without much help from fund investors, who've had relatively little appetite for domestic stock funds for the last two years.

The single most popular fund category this year is as dull as its name: intermediate-term bond funds, which invest largely in conservative corporate and government bonds.

On the risk scale, that's light-years away from the technology-focused funds that were the ill-fated darlings of small investors at the peak of the late-1990s bull market.

Robert Bruce Woodcox, a 59-year-old ghostwriter of fiction and nonfiction books, says he was day-trading stocks in the 1990s. Today, he says, the riskiest thing in his portfolio is the Schwab Yield Plus bond fund, which holds short-term government and corporate IOUs.

The fund's annualized yield is about 5.5%, and its share price, $9.67 on Friday, hasn't changed much; in the last year it has kept within 2 cents of that figure.

In his day-trading period, "I made a lot of money and I lost a lot of money," says Woodcox, who lives in Corona del Mar. "That stays with you for a long time." The experience accounts for his hankering to protect principal, he says.

Still, asked what he's doing for growth in his portfolio -- at 59 he could easily live 20 or 30 more years, I reminded him -- Woodcox admitted he has been thinking more about that issue.

He isn't likely to get much growth from his bond fund. That isn't the job of bonds.

Some fund-industry data suggest Woodcox has plenty of company in the play-it-safe camp:

* Net new cash inflows to domestic and foreign stock mutual funds totaled $84.1 billion from January through May, down 31% from the $121.3 billion in the same period of 2006, according to the Investment Company Institute, the fund industry's trade group.

Net cash inflow totals are fund purchases minus redemptions by investors who are selling out.

* While stock funds took in fewer dollars, bond funds surged in popularity. A net $79.8 billion in fresh cash flowed in during the first five months of this year, nearly four times the $21.1-billion inflow in the year-earlier period.

* Money market funds, which invest in very short-term IOUs and are designed to have virtually no risk of loss, took in more than either stock or bond funds. The net cash inflow to money funds was $94.3 billion in the first five months, up from $16.2 billion in the year-earlier period, although money fund investors include companies and institutions as well as individuals.

To put those numbers in perspective, stock fund assets total about $6.6 trillion, bond funds hold $1.6 trillion and money market funds hold $2.5 trillion.

In part, the ebbing cash flows into conventional stock funds reflect the rise of exchange-traded funds, which track broad or narrow market indexes and allow investors to better customize their stock portfolios. ETFs have mushroomed in popularity in recent years.

But add in ETFs and the picture doesn't change: Total net cash inflows to conventional and exchange-traded domestic stock funds lagged behind bond fund inflows in 2006 and are doing so again this year, according to Financial Research Corp., which tracks fund data.

It's Financial Research's data that show intermediate-term bonds as the single bestselling category of conventional funds and ETFs this year, with a net cash inflow of $32 billion in the first five months, double their intake in the same period of 2006.

One explanation for the demand for bond funds is investors' growing use of so-called target-date mutual funds in retirement savings plans. Target-date funds invest in other stock and bond funds in a mix designed to shift toward bonds as the investors near retirement.

Because bonds offer much more stability than stocks, it also makes sense that baby boomers like Woodcox would be turning more toward them as they approach retirement. That portfolio "rebalancing" may be a key factor in the shift toward bond funds.

The question is whether some investors are going too far, trading too much future growth in favor of near-term portfolio stability.

Another element of portfolio rebalancing has been the tilt toward foreign stock funds in recent years. Many U.S. investors ignored foreign markets in the 1990s. No more.

On average, foreign stock funds have outperformed domestic funds every year since 2003, and that streak continues this year. As the funds' performance has surged, investors have poured in.

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