Mutual funds boom despite scandal, market turbulence

Industry's assets rose to a record $8.12 trillion in February, institute says

April 03, 2005|By Laura Smitherman | Laura Smitherman,SUN STAFF

Neville Sinclair has dabbled in the stock market for about 20 years. But when it comes to his retirement savings, where he has socked an increasing amount of money recently, the 50-year-old Baltimore resident sticks with mutual funds.

"Mutual funds manage your money," he said before meeting with a TD Waterhouse adviser to roll money over into an Individual Retirement Account. "You're going to worry anyway, but this way I don't have to worry so much."

Investors like Sinclair are helping fuel a boom in the mutual fund industry, which has attracted unprecedented amounts of investment despite being battered by scandal and market turbulence.

Mutual funds reached a record $8.12 trillion in February, the Investment Company Institute, a trade group, reported last week. Money in funds that include stocks made up more than half of that, topping $4.9 trillion.

The mutual fund rise is due to several factors, including the aging baby boom generation eyeing retirement. But the industry has also gained from the public's painful memory of the dot-com investment craze before 2001, when everyone seemed to have an online brokerage account to trade the latest hot stock. Many came away from that experience more anxious about investing in individual stocks. They're turning to mutual funds, a collection of stocks and bonds picked by professionals.

The growing popularity of 401(k) plans and IRAs has fueled much of the industry's rise in the past two decades. It took more than 65 years for mutual funds to garner $1 trillion in assets and less than 15 years - from 1990 until now - to add another $7 trillion.

"Historically, most people owned more individual securities than mutual funds, and that has changed," said Richard E. Cripps, chief market strategist for Legg Mason Inc. "People who managed their money themselves were hammered during the bubble. They lost a lot of money, and they recognized they don't possess all the information they need to make a good investment decision."

Stock and hybrid funds last exceeded $4.9 trillion in August 2000 after the dot-com bubble burst and before the funds dropped to less than $3 trillion in 2002. Hybrid funds typically invest mostly in stocks with a mix of bonds.

Assets have since grown through appreciation, with markets rising in the past two years. But while the Standard & Poor's 500 index continues to lag behind its March 2000 high, mutual funds have recovered their asset base - and then some.

Some investors, drawn by lower fees and a wider array of choices, are speculating with mutual fund shares in hopes of quick profits. But experts say most investors are in mutual funds for the long haul. About one-third of all mutual fund assets are held in tax-advantaged retirement accounts such as 401(k)s and IRAs.

"This was the worst bear market in a generation," said Edward C. Bernard, president of T. Rowe Price Investment Services. "The first people who come back to the stock market are those who invest with professionals holding their hands and telling them, `I know this seems painful, but this is the best bet for investing over the long term.'

"That's important because when you look back at the scandals, there was some concern that people would lose faith in mutual funds," Bernard added. "Clearly that's not the case."

Mutual funds have been hit by allegations of market timing - rapid buying and selling of funds to take advantage of stock movements - that benefited select investors. Just last month, Citigroup Inc. and Putnam Investments, accused of not telling investors about potential conflicts of interest, were fined $60 million.

But while American households have taken money out of company stocks, cash has steadily flowed into mutual funds.

Households withdrew $447 billion from corporate equities in 2000, when Internet companies led an overall market decline. The hemorrhaging slowed and then picked up to $275 billion in 2004, according to the Federal Reserve.

Meanwhile, households put $280 billion into mutual funds last year, the Fed reported. In February, the industry's trade group said $22.4 billion went into stock funds, and hybrid funds attracted $4.3 billion.

Experts identify a long-term trend that mirrors a generational shift from workers who relied on pensions to workers who save for retirement through 401(k) plans, in which they have a choice of mutual funds.

"People who are much older tended to own individual stocks," said Brian Reid, chief economist at the Investment Company Institute. "People from the baby boom era are much more likely to hold them through mutual funds."

A national conversation about retirement security also may have prompted more investors to look at mutual funds, said Donald L. Cassidy, a senior research analyst for Lipper Analytical Services in Denver. The issue has become even more prominent as President Bush crisscrosses the country to stump for private investment accounts under Social Security.

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