In an attempt to sidestep market volatility, Ron McElhaney Jr., a 48-year-old married executive recruiter with four kids from Savannah, Ga., says he doesn't invest in individual stocks anymore. He also says he's watching every dime. "Splurging is ordering take-out food once a week," he says.
Signs of shifting strategy
The ongoing flight from stocks runs afoul of the historical relationship between stock market returns and fund flows. Historically, cash has chased returns. But this time not even the S&P 500's 108% gain since the bull market began in March 2009 has been enough to lure jittery investors back in.
Investors' overall exposure to stocks has also declined. The percentage of 401(k) investors in their 50s, for example, who have more than 80 percent of their account balances riding on stocks has dropped by almost half to 26 percent since 2000. That is due in part to an aging population in search of income and capital preservation.
The preference for less risk is also evident in the recent gravitation toward big, established companies that pay out a chunk of their profits to investors in the form of dividends.
Michael Rethman, a marketing consultant from Honolulu, has loaded up on dividend-paying stocks such as cigarette maker Philip Morris, drug companies such as Pfizer and toothpaste maker Colgate-Palmolive. Those stocks offer annual yields ranging from 2.4 percent to almost 5 percent. Dividend-payers are part of his "play-it-safe" trades, which also include investments in gold and deferred annuities that pay about 5 percent in annual interest.
The quest for safety is also illustrated by investors' willingness to buy 10-year U.S. government notes that, when adjusted for inflation, actually have negative yields. Some investors are so committed to making sure they get their initial capital investment back that they are willing to lose money to do so. "Is there anything more risk-averse than this?" asks Jeremy Siegel, a professor of finance at the Wharton School at the University of Pennsylvania.
Numbers also provide evidence of risk aversion, says Don Luskin, chief investment officer at Trend Macrolytics. Apple, he points out, is the world's most valuable company, with world-transforming products and super earnings. Yet it is selling at just a slight valuation premium to the broad market. Investors are also piling into 10-year Treasuries and are earning just 1.58 percent, less than the core inflation rate of 2.1 percent.
Similarly, analysts' profit estimates for S&P 500 companies are at an all-time high, yet the price-earnings ratio for the broad market is roughly 13, which is about where it was at the market trough in March 2009.
"This tells you that investors are as scared as they were at the bottom of one of the worst bear markets in history," says Luskin.
The play-it-safe trend is best summed up by an investor poll conducted in August by TD Ameritrade: One out of three investors said they had taken on less risk over the past six months.
Where the fear came from
Why is safety in vogue?
"Better to be safe than sorry; it is as simple as that," sums up Sung Won Sohn, an economics professor at California State University.
The disconnect between investors' perception of the stock market and how it is actually performing has sparked a debate as to whether the era of risk-taking is over.
"Animal spirits (or the confidence to take risk) may come back, but there is no guarantee that they will," says Gregory Whiteley, a portfolio manager at DoubleLine Capital. "This type of risk-averse behavior is not easy to change. It's kind of a learned behavior that becomes ingrained."
The origin of the fear is now well known. A pair of 50 percent stock market drops in the 2000s. A real estate crash. Sinking confidence. And a severe recession that has cost millions of Americans their jobs.
The financial hit has been huge. The median wealth of U.S. families fell by a median 38.8 percent over the 2007-2010 period, according to the Fed's latest Survey of Consumer Finances.
Fewer jobs. Smaller paychecks. Less wealth. That dismal equation does not add up to a swing-for-the-fences investment mentality, says Charles Biderman, CEO of TrimTabs Investment Research. "People … are not willing to take as much risk," he says.
Uncertainty about the current state of the global economy is another headwind. Europe's debt crisis has still not been resolved. China's economy has slowed suddenly, boosting fears of a more acute global slowdown. And the U.S. is facing a fiscal crisis of its own if Congress doesn't extend the Bush-era tax cuts and if it cuts government spending too much too fast in an effort to reduce the deficit.
Computer-created stock market mayhem in recent years hasn't exactly boosted investor trust, either. The flash crash in 2010 and the snafu at the Nasdaq stock market during Facebook's IPO have also given investors pause.
Ironically, playing it safe has not been a winning investment strategy the past few years, says Thorne Perkin, managing director at Papamarkou Wellner, an asset management firm that caters to wealthy clients and institutional investors.
"Since 2008, the cash trade has been the pain trade," Perkin says. The pain has been watching cash balances stay the same due to 0% interest rates while the stock market has doubled. Yet, even the firm's wealthy clientele has raised their cash positions to 20% to 40% of assets, he estimates.
The problem? "Everybody seems perplexed as to why the markets have been so buoyant," given all the bad news overhanging the market, Perkin says. That uncertainty keeps investors cautious.
Risk-taking will return
So is the era of investors swinging for the fences over?
"The age of risk-taking is not over, nor should it be. America was built on taking risks," says Anthony Sabino, a law and finance professor at St. John's University. But Americans must start taking more intelligent risks. "We should have learned that assuming real estate always goes up, that IPOs always flourish and that those promised double-digit returns are real — and not a Ponzi scheme — are foolish risks," he says.
So what will give investors the confidence to take chances with their cash again?
Confidence in the future, mainly in the form of jobs and better pay, will provide a new foundation for investors to start building wealth again, Biderman says.
Perkin says risk-taking will return when individuals are done paying off debt and when investing gets back to basics such as valuing companies on their business fundamentals rather than worrying about whether Europe will implode.
Investors will return to stocks when they realize playing it safe is keeping them from reaching their financial goals, says Timothy Fidler, a portfolio manager at Ariel Investments.
"Right now, people are reaching for safety," he says. "Eventually people will need to reach for return again."