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The coming return to equity funds

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One of the paradoxes of the stock market in recent years has been the fact that even as it keeps going up, the amount of assets in domestic equity funds continues to decrease. According to the Investment Company Institute, more than $150 billion flowed out of domestic funds in 2012, despite the fact that the Standard & Poor’s 500 index rose by 16 percent over the course of the year. That’s an awful lot of investors who lost out on the opportunity to make a significant amount of money.

But there are reasons to think that the tide will turn in 2013, and that investors will finally start to return to these types of funds. Perhaps foremost of these is simple common sense on the part of American investors. The S&P has more than doubled since hitting bottom in March 2009, even as it has lost the fuel provided by all those domestic mutual funds.

It’s not just the growth of the market but its consistency that should shake off investors’ fears. In 2012, the S&P index never once fell below the level at which it finished 2011. There was never a single moment all year when an investor in the Vanguard 500 would have looked at his or her portfolio and realized they had lost ground.

That confidence should continue to grow throughout the year. In March, two months from now, we will be four years removed from the market’s bottom, and even further away from the catastrophic crash that began in 2008. There’s no question that investors are still wary of the market, but that should continue to ease.

Investor confidence has been returning as well. In a survey conducted for the financial information service Ignites, its subscribers were asked for their predictions for the coming year. The most popular answer was that investors would be coming back to equities.

In another survey, conducted in the fourth quarter of 2012 for the John Hancock Investor Sentiment Index, nearly half of investors who responded — 48 percent — said they thought this was a good time to invest in equities. By contrast, only 27 percent said that this was the right time to be investing in bonds.

Those kinds of attitudes could signal a coming shift in the investing patterns of the past few years. In contrast to the assets flowing out of stock funds, bond funds have been advancing by leaps and bounds. While equity funds were losing that $150 billion last year, bond funds took in a robust $400 billion.

There have been signs of the bond market softening as well. The Wall Street Journal reported last week that the average yield of high-yield bonds had dropped below 6 percent for the first time in history. So investors turning to fixed-income instruments are finding it increasingly difficult to generate income that can compete with stocks.

Meanwhile, the benchmark ten-year U.S. Treasury bond remains stuck under 2 percent. The so-called safe haven isn’t even returning enough to beat inflation.

That leaves equities as a vehicle that is feeling safer each day, and returning enough to justify the risk they entail. In that light, the question is not so much when investors will return to equity funds, but why they haven’t yet done so.

There is one strong demographic tide fighting against that idea, though: the aging of the baby boomers. People are told almost from the time they begin investing that they should turn to safer investments as they grow older, shifting from equities into bonds. The baby boom generation has taken this advice to heart. In 2011, according to data compiled by the Investment Company Institute, only 10 percent of households headed by someone aged 65 or older were willing to take above-average or substantial investment risk. Meanwhile, 19 percent of households headed by someone from 50 to 64, and 26 percent of those households headed by someone between the ages of 35 and 49, were willing to take on that kind of risk.

We can see this show up in the types of assets in people’s 401(k)s. In 2010, the most recent year for which the ICI has figures, only 38 percent of 401(k) participants in their sixties had more than three-fifths of their assets in those accounts invested in stocks, but that number rises to 70 percent of 401(k) participants in their forties.

That demographic factor may be the biggest reason assets haven’t flowed back to equity funds yet. But that may be the final obstacle standing in the way of increased flows back into the classic American stock mutual fund.

For more from Tom Nawrocki, see:

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