The New Normal: Risk Aversion Is Here to Stay

New numbers show that risk aversion is deeply entrenched.

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With a crushing recession and a still-fickle economy weighing heavily on Americans' minds, it should come as no surprise that investors aren't exactly in the mood to ratchet up their risk profiles. A recent survey by the Investment Company Institute confirmed this sentiment, showing that among mutual fund shareholders, risk appetite hasn't rebounded at all since 2008. As the stock market continues to zigzag and bond funds keep attracting an overwhelming majority of new money, this trench-warfare approach to investing isn't showing any signs of letting up.

[See U.S. News's list of the 100 Best Mutual Funds for the Long Term, and use our Mutual Fund Score to find the best investments for you.]

The ICI numbers, which were released earlier this week, show that 30 percent of mutual fund owners would be willing to take "above average" or "substantial" risk in an attempt to stretch for returns. That number remains unchanged from last year. In 2008, 37 percent said they'd do so. The effects of this sustained skittishness are quite apparent: Between the beginning of 2009 and the end of last month, investors pulled a combined total of $28 billion out of foreign and domestic stock funds, according to the ICI. Over that same time period, they poured $592 billion into bond funds.

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Experts say that investors are unlikely to regain their nerve anytime soon. Risk appetite peaked in the late '90s, according to ICI Chief Economist Brian Reid, and that built-up confidence was the result of a decade of the S&P 500 averaging gains of more than 17 percent per year. "The experience of the '90s was that you had outsized returns in stocks, so people probably had an outsized tolerance for risk," says Reid.

The 2000s, of course, were a different story, and over the course of the decade the S&P 500 bled an average of 1 percent per year. But that number only begins to capture the true toll of the "lost decade." Figures released this week by TrimTabs Investment Research show that at least half of investors in U.S. stock funds lost more than 25 percent (that's a total, as opposed to annualized, loss) over the course the past decade, largely because of failed attempts at timing the market. And if it weren't for some of the solid years in the lead-up to the recession, that number would be even more painful.

[See Mutual Fund Buzz for September 28: Investors Lost Big Last Decade.]

So what would it take to wean investors off of bonds? "We would need another virtuous cycle [in order] to build confidence," says Jeff Tjornehoj, Lipper's research manager for the United States and Canada. "It could take a couple of years, frankly, because the hurt from 2008 and from the current [situation] is so front-and-center in investors' minds."

The bond rush, of course, has been nourished by more than just fear. On the one hand, the country's aging population is making a natural transition away from equities and into fixed income. At the same time, there has also been some performance chasing. After all, long-term treasury funds have gained upward of 24 percent year-to-date, according to Morningstar.

But more than anything, the bond flows and the ICI numbers make clear that investors are still coming to terms with how quickly their wealth can disappear. "I think that in past downturns, you could point to 10, even 20 percent losses, and people thought that was something you could make up in a year or two," says Tjornehoj. "When you take a 35 or 40 percent loss, then it's several years just to get back to zero."