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Would Mutual Fund Holders Panic If Stocks Plunged?

Economic Trends


With millions of individuals still pouring money into mutual funds despite the market's recent gyrations, some seers fear that a nasty spill in the stock market could easily spiral out of control if novices panic. And the plunge could affect the real economy, as battered investors rein in their spending. To prevent such a chain reaction, economist Henry Kaufman suggests a cooling-off period, perhaps up to 90 days after investors put in their sell order, before they can take their money out of the fund. "There is a possibility that mass liquidations will cause significant price declines in the equity markets," says Kaufman. "This is a risk that has not yet been tested in the postwar period."

But the fears may be overblown. Yes, the share of household financial assets now held in stocks and bonds is at 75%, the highest level since 1961. But most individuals are investing for the long haul, namely retirement, says Donald P. Morgan, a senior economist at the Federal Reserve Bank of Kansas City. Writing in the bank's latest Economic Review, Morgan notes that the stock and bond investing boom closely parallels another trend: the aging of the workforce. Since 1978, the percentage of all workers 35 and older--the age at which most individuals begin to plan for retirement--has grown from 56% to nearly 63% (chart). To Morgan, that explains a good part of the move into financial assets.

Morgan also disputes the idea that a sharp market decline will wreck consumer spending. The markets suffered some sharp downturns during the 1950s and 1960s, when households held as much in stocks and bonds as they do now, yet consumer spending growth remained relatively stable. Citing other Fed research that suggests households reduce consumption by 5 cents for every $1 decline in their wealth, Morgan calculates that a 1987-scale market crash would cut consumer spending by no more than $66 billion--or 1% of gross domestic product.DEAN FOUST

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