Price Plunge Unlikely to Spur Rush to Sell

There’s something about October that makes investors, financial advisers and business journalists see demons in the night.

Not Halloween goblins, mind you, but the ghosts of market crashes past.

Several crash-oriented news articles have appeared in recent weeks around the country, and investors are perhaps understandably nervous, considering the high valuation of the domestic stock market and October’s reputation for mischief.

Some people are especially concerned that the rapid growth of mutual funds--and the influx of new investors--could lead to increased volatility in the stock market.

The fear is that when novices get their first real taste of downward volatility, they will run for the hills.

Could it happen? Sure.

But there’s also evidence to suggest that most fund shareholders aren’t as fickle or naive as you might think--and that many will sit through the next bear market with their portfolios more or less intact rather than bail out at losses.

A recent study by Strategic Insight, a New York mutual fund consulting and research firm, indicates that investors haven’t been net sellers during past downdrafts.

An evaluation of seven bear markets over the past 30 years revealed that fund redemptions declined each time, says Avi Nachmany, an analyst at the firm. “The myth that people do redeem to a large extent when the market turns south is absolutely false,” he says.

Nachmany explains this by observing that people don’t like to admit that they’ve made mistakes--so they will defer selling until prices recover.

In fact, says the Investment Company Institute in Washington, only 2% of stock-fund assets were redeemed by shareholders on the worst day in modern times--Oct. 19, 1987, when the Dow Jones industrial average tumbled 508 points.

Cynics might point out that many investors didn’t have time to react on that date and could be more likely to throw in the towel during a prolonged slump. Yet the Strategic Insight study did include some lengthy retreats such as the severe 1973-74 bear market.

Young investors with a long-term horizon should actually want to see prices drop from time to time since it enables them to purchase more shares at lower prices, says Paul Merriman, head of the market-timing Merriman Funds organization in Seattle.

But older investors who aren’t blessed with having as much time on their sides should stick with defensive equity portfolios, he suggests.

What about the hordes of novices of various ages who have recently moved money into stock funds for the first time--could they become a major destabilizing factor? Numbers compiled by the ICI, the fund industry trade association, suggest that this threat too is overblown.

“A number of recent articles have been trying to relate the growth of mutual funds to the potential for stock or bond market crashes,” said L. Erick Kanter, an ICI vice president.

Yet the group says that most of the money now flowing into mutual funds isn’t coming from unsophisticated bank customers but rather from existing shareholders adding to their positions.

According to the ICI, the stock market isn’t especially vulnerable to the whims of fund shareholders--experienced or novice. A “common misconception is that mutual funds dominate the U.S. stock market,” Kanter writes in a recent letter to financial journalists. But in fact, funds own only 9.8% of the $5.7 trillion worth of domestic equities--well below the holdings of individual stockholders (49.6%) and private pension plans (18.1%).

It’s hard to predict how investors will react during the next bear market, but a recent survey by Neuberger & Berman, a New York-based fund company, suggests that many will stay the course.

Neuberger & Berman asked 500 fund investors whether they would buy or sell if the market fell 10%, 20% or 40%. In each case, more respondents said they would buy.

“Speculation that mutual fund investors would abandon stocks en masse in a market break is wrong,” said Stanley Egener, president of Neuberger & Berman.

“Even accounting for a difference between what people say and what they do, most fund shareholders confirm they’re in for the long haul, acting as a stabilizer for the market.”

In the Neuberger & Berman study, 76% of those questioned said the bulk of the money they have invested in mutual funds won’t be needed for at least five years. Many observers assert that the increase in fund holdings within retirement plans is in itself a stabilizing factor.

“When you’re a long-term investor, you’re less concerned with short-term fluctuations,” says Nachmany, who points out that 80% of net mutual fund sales in 1992 went into long-term retirement or institutional accounts.

In general, stock-fund buyers today are better educated than ever about risks, the merits of long-term investing and other financial matters, says Neal Litvack, an executive vice president at Fidelity Investments in Boston.

“On the stock side, I’m relatively comfortable that newer investors have done their homework,” he says. “Baby boomers may be stepping into the stock market for the first time, but they’re doing it with their eyes open.”

But Litvack isn’t so optimistic when the topic turns to bond funds. Here, he says, the typical new investor tends to be older, more risk-averse and less knowledgeable about financial products--the sort of saver who could panic in a bear market.

“Many of these people still don’t understand the various risks, such as that posed by rising interest rates,” Litvack says. “The bond-fund side is where my greatest concerns lie.”

A Month to Forget? October is traditionally viewed as a downer month in the stock market, which shouldn’t come as a surprise considering what happened in 1929 and 1987. But in general, October really hasn’t been that bad to investors. On average, here’s how the Standard & Poor’s 500 index has fared in each month of the year, from January, 1950, to April, 1993.