Experts Fear Effects of Flight : Many Small Investors May Not Buy Stocks for Years

Stunned by the Great Crash of 1929 and its aftermath, small investors by the thousands swore off investing in the stock market and never came back. After the steep market decline of 1969-70, many small investors also fled stocks. The anemic but occasionally tumultuous market of the mid-1970s left many more reluctant to participate in equities.

Now, the Great Crash of 1987--and the bear market or recession that could follow--may leave small investors so chastened that many may cut back or quit investing in stocks and stock mutual funds for years, experts fear.

“This is going to frighten off a lot of small investors and quite a few big ones too,” Harvard economist John Kenneth Galbraith said. “I suspect there will be a substantially more cautious approach to investing after this.”

“The history of bear markets is that individuals stay out for quite a long time after,” said Allen Sinai, chief economist for the brokerage firm of Shearson Lehman Bros.

Further flight of individuals from the market could have widespread implications. The stock market has given millions of Americans a stake, real and emotional, in the capitalist system; but if stocks remain in the doldrums and small investors stay away, the damage to that sense of participation may be profound.

Individual investors could reduce their use of stocks in individual retirement accounts or 401(k) company savings plans. Some mutual funds may flounder with too few customers. Brokerage houses also could suffer. On the other hand, sales of government securities, money-market funds and insurance products could benefit.

A small-investor pullback also would continue a decades-long trend in which institutions such as pension funds have increasingly dominated stock ownership and trading, accounting for as much as three-fourths of all shares owned.

Of course, how many small investors are discouraged will depend on whether the market can rebound from its devastating losses since Aug. 25. The 289-point rally of Tuesday and Wednesday brought many back into the market searching for bargains. Several brokerages reported strong upsurges in customer buying volume on those days.

Many Did Not Leave

Also, many small investors have not left the market because they were not hurt that hard in the crash. They tend to invest in stocks of smaller companies and in mutual funds, both of which fared better than the big blue-chip issues that make up the Dow Jones industrial average.

Small investors who have been in the market since 1982, when the bull market began, also may stay in, noted John Markese, director of research for the American Assn. of Individual Investors. They are still ahead since 1982, as the Dow average is still more than double its low of 776.92 on Aug. 12, 1982, he said.

But those who invested within the past three or four months, and who consequently lost the most from Monday’s crash, may not come back for a long time. Others who thought about investing may think twice.

Clearly, quick and devastating declines, particularly after periods of speculation, can drive many small investors away. That was dramatically shown in the aftermath of the 1969-70 market slump, the most severe postwar decline until the current one.

‘Go-Go’ Years

During the middle and late 1960s, known as the “go-go” years, many investors were drawn into the market amid rising stock prices driven by speculation and a conglomerate merger movement.

But the ensuing bear market, along with another in 1973-74 and the inflation that followed, made stocks a generally poor investment in the 1970s. That so discouraged small investors that the number of individuals who own stock or stock mutual funds fell 18% to 25.27 million in 1975 from 30.85 million in 1970, according to the New York Stock Exchange.

Individual ownership of stock or stock mutual funds has recovered since then and has grown during the bull market to total about 47 million people--about one in four adult Americans. But the bulk of that growth has come through investing in mutual funds, as individuals refrain from owning stocks directly because of a desire for greater diversification and professional management, fear of the market’s volatility and a perception that professional traders have unfair advantages.

Slight Fall

Direct ownership by individuals of shares traded on the NYSE actually fell slightly between 1983 and 1985, the exchange said. (A far higher number of Americans--133 million as of 1980, according to the NYSE--own stock indirectly as a result of their life insurance policies, pension plans and relationships with college endowment funds and other institutional entities.)

Already there are signs that individuals have been rattled by the stock plunge. Prices of Treasury bills, notes and bonds have surged because of heavy demand, some of that buying no doubt coming from small investors. Some experts suggest that government securities may be the best-performing investments during the next few years, if stocks flounder.

During the two decades after the 1929 crash, government bonds indeed were the best-performing investment, beating stocks by a wide margin, said Kenneth L. Fisher, president of a Woodside, Calif., money management firm and author of “Wall Street Waltz,” a book of charts chronicling the history of stock price movements.

Product Booms

Insurance investments also could benefit from a stock pullback. One product, single-premium life insurance--which requires only one premium payment and provides coverage as well as tax-deferred investment income--already is booming thanks to its generous tax benefits.

Investors also are flocking to conservatively managed mutual funds.

Money-market mutual funds, which invest in relatively safe short-term credit instruments such as Treasury bills and bank notes, this week surged to record levels as investors switched money out of stock mutual funds.

Some mutual fund officials, however, are worried. Any pullback by individual investors could hurt their industry, which enjoyed unprecedented growth during the 1982-87 bull market and formed new funds at the rate of one a day in recent months.

Slump Possible

Although growth may continue in money-market funds and funds that invest in bonds, stock funds could slump, officials fear.

Stock funds that charge commissions, or “loads,” particularly could suffer because in a flat or declining stock market, those fees have a more significant negative impact on investor profits.

“When the stock market gets a kick in the teeth, it has always slowed down the growth of the mutual fund industry, and it will do so this time,” said John C. Bogle, chairman of Vanguard Group, one of the nation’s largest mutual fund companies.