Many investors are gasping at the first-quarter losses on their financial statements and wondering whether they should change their asset allocation to a more conservative plan.

A massive shift of mutual fund assets from stocks to money market mutual funds could deal a huge blow to economic recovery, but fortunately, most investors are likely to do nothing, experts say.

"Most people who are not well versed in finance tend to react more emotionally than is probably in their best interests," said Blaine Aikin, president and CEO of the Sewickley, Pa.-based Fiduciary 360. "We have the tendency to do the wrong thing when we get scared. It's probably a good thing that most people are not actively modifying their investments."

The investor apathy that led to the creation of the Pension Protection Act of 2006 and its automatic enrollment proviso may keep the majority of 401(k) participants locked into their plans, provided the analysts are correct with their predictions of a short recession.

"Most investors should be looking at a long-term horizon," said Tom Roseen, a senior research analyst for Lipper. "This is the time to be putting money into the market." Roseen said he is confused by the behavior of investors. Instead of buying low and selling high, many are doing the opposite.

But it's difficult to focus on the long term when headlines continually blare of huge write-downs and massive layoffs.

If investors were to make a massive switch from stocks to money market funds, Aikin noted, there would be a significant drop in the markets overall.

"The question is: How quickly would it come back?" Aikin said. "A lot of selling is typically the sign of the bottom. Unfortunately, the least-sophisticated investors are usually the last to act. They're usually the ones who make the wrong move at the wrong time."

"The bad news seems to go on and on," said Don Phillips, managing director of Morningstar. Phillips said he isn't seeing a mob of people pulling out of their 401(k)s or dramatically altering the allocation of their assets, but there is definitely a shift toward conservatism as investors try to limit their losses.

"Money market mutual funds are the most notable, as well as government bonds," he said. "The more conservative funds are getting more asset flows."

"Fund companies will naturally try to appeal to that conservatism in markets," Phillips said. "It would be a very bold action for a mutual fund to start an aggressive campaign at this time. Firms are much more likely to promote conservatism, such as market-neutral funds that provide steady, absolute returns."

Unfortunately, some of the conservative areas investors flocked to, such as the Schwab YieldPlus Fund, turned out to not be the sanctuaries investors were hoping for, Phillips said.

"The current market is very different from 1998 and 1999," he said. "Back then, investors were courting volatility and leaving mutual funds for individual stocks. Ten years later, we are seeing the exact opposite. Ten to 15 years ago, we thought if we just created a good lineup of products, people would figure out how to use them."

As a result, the mutual fund industry is becoming more paternalistic, Phillips said.

Mutual fund executives are learning that the behavioral aspects of investing play heavily into the minds of investors, he said. The industry can create the building blocks for a good fund, but that doesn't necessarily lead to good results. Many investors need to have a map to the right choice that appears to be a custom-built and very precise portfolio, he said.

For many investors, the answer may be target-date maturity funds, Phillips said, which base the risk level on the participant's age.

As more employers move toward auto enrollment for defined contribution plans, target-date funds seem to be among the best qualified default investment alternatives, although a one-size-fits-all approach won't work for everyone.

Plan participants have different risk tolerances and return expectations, and many have investments outside the plan that should be considered. Most plans allow those investors with the time and the interest to personalize their 401(k)s, and employees always have the option to opt-out if they choose.

"Whenever investors are auto enrolled, it's a very effective way to make sure you are buying more when prices are low and buying less when prices are high," Aikin said. "Auto enrollment is something we need. If we push more and more responsibility of retirement saving to individuals, it needs to be accompanied by auto enrollment and auto escalation."

Success has been on the side of consistent investors, not people who try to time the market, he said.

"Would people be able to make the choice to do the right thing if they were more involved in their plans?" Aikin asked. "Inactivity in this case may be a good thing."

(c) 2008 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

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