Mutual Funds
Are investors being set up for a fall?
Flows into stock funds haven't been this high since right before the bubble burst in 2000.
March 5, 2004: 3:42 PM EST
By Jeanne Sahadi, CNN/Money senior writer

NEW YORK (CNN/Money) Given that inflows into stock mutual funds in January were the third highest in history, it's easy to wonder: Are investors setting themselves up for a fall?

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Buying in January, after all, meant buying after huge runs in 2003 for the S&P 500 and the Nasdaq -- 26 percent and 50 percent, respectively.

And investors have been known to chase performance, buying on the way up, if not at the tippy top.

That's what happened in February 2000 and January 2000 the eve of a three-year bear market. Those months rank as No. 1 and 2 in terms of net flows to stock funds.

Then, as stock prices sank lower and lower, individuals sold, with net outflows from equity funds in 2002.

But the market rebound that began in March 2003 brought investors back, and net flows to stock funds have been positive ever since. Flows in January were close to $44 billion, according to the Investment Company Institute. And it looks like net flows will be positive in February as well although not as high as January's, according to preliminary estimates from fund-flow tracker TrimTabs.

What's more, Hewitt Associates, the global outsourcing and consulting firm, which tracks investor behavior in 401(k) plans, found that January was "the most decisively equity-oriented transfer activity month" since it launched its 401(k) index in 1997. Ninety percent of all transfers involved monies moving from fixed income investments to stock investments.

Performance chasing or rebalancing?

These moves, however, don't necessarily indicate that individual investors have once again been taken in by speculation.

For one, January is often one of the highest months of the year for net flows to stock funds because of year-end events that free up money for investment. In 2003, for instance, bonuses were higher than they've been in awhile, and companies put about $100 billion into their underfunded pensions, said Charles Biderman, founder of TrimTabs, which examines stock market liquidity.

And it's not as if 401(k) participants are wildly overexposed to stocks. Though there was a high level of transfer activity from fixed income to equities in January, the monies transferred accounted for less than 1 percent of all 401(k) money tracked. And equities accounted for only 66 percent of the average 401(k) balance, according to Hewitt. The record high since the launch of the index was 74 percent in March 2000.

In addition, in terms of where investors were putting their money, there's no clear indication that they have been behaving like lemmings on a bender.

According to a list culled by the Financial Research Corporation, the funds that attracted the most cash in January tended to be well-known funds many of them middle-of-the-road plays or at least not highly risky ones -- run by well-known families: American Funds, Vanguard, Fidelity and Dodge & Cox.

In terms of the fund categories there's greater evidence for performance chasing the majority of the top categories collecting cash did well in 2003. But given that moderate allocation funds ranked No. 2 might be an indication that while investors feel it's safe to get back in, they're not going crazy.

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Certified financial planner Doug Flynn doesn't discount investors' tendency to invest in what did well most recently, but he wouldn't characterize January's big inflow numbers as chasing, at least not the kind that characterized the Internet boom.

"People do feel better about investing," Flynn said. "But they are still very skeptical about the recovery and their expectations are way down."

And though valuations may be higher than they were a year ago, Flynn said, if you have long-term goals for the money you're investing, and you're not overexposing your portfolio to stocks given your time horizon and risk tolerance, he said, then now is as good a time to get in as any.

"We're in inning 2 of the new ballgame. So get in and let it go the rest of the innings," Flynn said.

But, he cautioned, just make sure you don't turn tail the next time things go sour for stocks.  Top of page

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