Fight on, or fall back?

Fight or flight? For millions of investors, worried about the prospect of grim returns for the rest of 2001, the question is stark and daunting. Yet, the answer has come through loud and clear: Small investors - in many respects the backbone of the US financial system - have chosen to fight.

With few exceptions, they are staying put in mutual funds and individual stocks, despite sagging returns for the quarter and year to date - not to mention the uncertainty cast upon the market by last month's terrorist attacks and Sunday's military strikes by the US and Britain. Stock market defectors after Sept. 11 came largely from institutions, such as large pension funds using special computer-sell programs.

"Just based on anecdotal evidence, we are not finding any unusual level of redemptions by individuals from mutual funds," says Chris Wloszczyna, a spokesman for the Investment Company Institute (ICI), the national association of the fund industry in Washington.

Although some investors were pulling out of stock funds well before the World Trade Center disaster - based on weaknesses in the economy - flows into these funds remain in positive territory for the year, with even more money going into bond and money-market funds. During the third quarter, outflows from stock funds accelerated. But flows increased into both money-market funds and bond funds (see chart, page 17).

Overall, fund ownership keeps rising. According to the ICI, 54.8 million US households - 52 percent of all US households - own mutual funds, a 3 percent rise over last year. And a new poll of some 1,000 Americans indicated that half had purchased, or plan to purchase, "some type of financial product or security" specifically to help the US economy, according to InsightExpress, an online market-research firm.

Those already in the money-market and bond categories likely profited during the past quarter. But returns on equity funds, especially after the destruction of the twin towers, can only be called dismal.

Virtually every stock mutual-fund sector lost ground, with two exceptions: gold funds and bear funds. Gold gained an average of 2.3 percent in the third quarter, but has taken a hit in recent trading sessions. Bear funds did even better, producing double-digit returns.

Bear funds tend to profit by owning options on equities rather than actual stocks, in anticipation that stocks will lose value. Both gold and bear funds are volatile. But bear funds are also expensive, often requiring $10,000 to $25,000 to open an account.

For holders of fixed-income funds, there was particularly good news during the quarter. The bond market posted solid gains, especially for intermediate-range bond products of three years or more.

Public attention, not surprisingly, has been riveted on the terrible destruction in New York and the first round of US reprisals. Many US financial firms were both financially and personally affected by the tragedy. But longtime financial experts insist that to gain a clear perspective, investors must look far beyond the immediate impact of the terrorist incident and even armed conflict.

"What happened at the World Trade Center was a terrible personal tragedy," says John Markese, president of the American Association of Individual Investors, in Chicago. "But the impact on financial markets is not as severe. Events like this, as terrible as they are, tend not to have lasting impact."

Unless people have unusual circumstances or changes in their lives, we tell them to "do nothing to alter their own personal investment plans," Dr. Markese adds.

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