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Good call? Mutual fund investors have been turning back to bonds, away from stocks

June 1, 2011 |  5:38 pm

The conventional wisdom is that small investors tend to follow market trends, not lead them.

But data on mutual fund purchases and sales this year show that individual investors began turning away from stocks -- and back toward bonds -- beginning in March.

Those shifts look prescient now: Even before Wednesday's steep stock-market sell-off on worries about the slowing economy, equities had struggled in the current quarter since key indexes reached multiyear highs in late April.

Meanwhile, bond prices have been rising since early April as market interest rates have continued to slide.

Mutual funds that own U.S. stocks had net cash outflows for five straight weeks through May 25, totaling $8.9 billion, the Investment Company Institute said Wednesday. Net cash flows measure new purchases minus redemptions.

The outflow is small compared with the $4.2 trillion total in domestic stock funds, but it's a big switch from early in the year, when money was pouring in. The funds had net cash inflows of $19.7 billion in January and $12.9 billion in February, when share prices still were climbing.

While money has been exiting stock funds over the last month, bond funds have been raking it in: Taxable and tax-free (municipal) funds took in a total of $23.5 billion in new cash over the last five weeks, up from $13 billion for all of April and $11.5 billion in March, ICI data show.

Bonds were the favored investment of millions of Americans in 2009 and 2010 as they sought relative safety -- and peace of mind -- after the stock market crash of late 2008 and early 2009.

So far, investors' tilt back toward bonds is paying off: Bond fund returns are solidly in the black since March 31 while many stock funds are modestly in the red.

The Vanguard Total Bond Market Index fund now is up more than 3% in the second quarter, while the Standard & Poor's 500 stock index is down about 0.5%, including dividends. (See this post for second-quarter and year-to-date returns of popular stock and bond funds through last Friday.)

The bigger picture, as noted in a new Prudential Financial survey, is that many small investors show no signs of losing their distaste for stocks, even though it has been more than two years since the market bottomed.

Being totally out of stocks feels smart on days like Wednesday, when prices dive. But investors who've forsaken the market entirely have left a lot of money on the table as shares have rebounded from their 2009 lows.

-- Tom Petruno