Stocks: The Individual Investor's Dilemma

The drama of the current financial crisis has featured star turns by Wall Street titans and Washington power players. But what about the little guy?

The worst stock market in a lifetime has left the average investor stunned. After the past year has taken a bite of 40% or more out of their portfolios, investors are split on whether to run away from equities, buy more, or stay the course.

Many institutions and wealthy investors are being forced to pull out of the market. Hedge funds, for example, are selling off stocks because credit troubles make it harder to invest using borrowed money, and customers are demanding their money back. Investors withdrew an estimated $40 billion from hedge funds in October, according to Hedge Fund Research.

Ignoring Buffett's Advice

But at least in theory, individual investors should be better able to withstand a downturn. Billionaire investor Warren Buffett is buying stocks and urging others to do the same, citing dirt-cheap valuations on many of the best U.S. companies.

There's only anecdotal evidence that individual investors are actually following this advice. Financial advisers interviewed by BusinessWeek.com say a small percentage of their clients—often those who are younger and further from retirement—are shifting more of their portfolio toward stocks.

Others, clearly, are yanking their money out, or shifting their portfolios toward safer investments such as cash or bonds. According to TrimTabs Investment Research, almost $165 billion has been pulled out of equity mutual funds since early September.

Few investors are taking the drastic step of pulling all money out of investment plans. Hewitt Associates (HEW), a firm that runs 401(k) retirement plans for 2.7 million U.S. workers, says only 4% of employees have stopped contributing to 401(k) plans entirely this year.

Reallocating 401(k) Assets

But as stock markets plunge, fewer individual investors are buying stocks. According to Hewitt Associates, 53.8% of 401(k) assets are held in equities, down from 68.1% a year ago and the lowest since the firm started tracking the data in 1997. A survey by the American Association of Individual Investors shows individuals allocating only about 45% of holdings to stocks, down from a historical average of 60%.

Falling markets have prompted many to fuss over their plans: A total of 1.25% of 401(k) balances were moved around in October alone, almost three times the historical average. Often these adjustments come at the worst possible time during a volatile market: Investors will sell the day after the market falls and then buy after the market rises—essentially committing the classic investor error of selling low and buying high, says Pamela Hess, Hewitt Associates' director of retirement research.

Why You Shouldn’t Bail on Stocks Now