Financial crisis ushers in 'The Age of Safety' for investors

NEW YORK -- Americans' risk-taking DNA code has been short-circuited.

Investing used to be about taking risk to make money. Then came the financial crisis four years ago and the Great Recession. Now it's more about playing it safe — and not losing the money you already have. The "risk-off" trade, or dialing down risk in a major way, is the new "in thing."

Risk aversion is at unprecedented levels. Cash, which guarantees a return of 0%, is one of the new must-have investments. In contrast, investing in stocks — despite the fact that the market has doubled in value since March 2009, is trading at four-year highs and is up 12% this year — has fallen out of favor.

Welcome to The Age of Safety.

A psychological shift has taken place in the minds of investors. Fear has replaced greed as the overriding emotion driving investment decisions.

"You can go all the way back to the early 2000s, when the Nasdaq technology stock bubble burst. Then came 9/11. Since then, you have had the creeping realization that it is a more dangerous world," says Peter Crane, president of Crane Data, a firm that tracks money market cash flows. "Then the 2008 financial crisis drove home the point that it is a much more dangerous financial world. Both businesses and individuals realize they need larger cash war chests."

As a result, he says, cash is viewed as the only true safe harbor.

There's no shortage of statistics that scream "safety":

•Cash hoarding. A record $9.43 trillion — enough cash to buy 120 of the biggest companies in the Standard & Poor's 500-stock index — is now sitting in money market mutual funds, bank savings accounts and CDs, according to Crane Data.

But all that cash isn't making anyone rich.

"The rate of return is effectively zero," Crane says. "How much of the $9 trillion is scared money is arguable. But the overall numbers are gigantic."

Getting no return, however, has not stopped Bruce Tepper, 67, and his 66-year-old wife, Nancy, from squirreling away excess cash in a money market checking account. "It's earning next to nothing, but the money is accessible," he says.

•Rich retrenching. Even the richest of the rich, the One Percent, are thinking defense first, according to "The 2012 Survey of Affluence and Wealth in America" from American Express Publishing and Harrison Group. One Percenters put 56% of their free cash into savings and money market accounts last quarter, up from 24% in 2007. In contrast, they are investing only 44% in financial markets, down from 76% five years ago.

"Their speculative impulse is way, way down," says Harrison Group Vice Chairman Jim Taylor, adding that the mega-rich now equate the stock market with "real risk."

•Mom and pop selling.Main Street investors have been lightening up on stocks since the financial crisis. In the four years ending 2011, individual investors yanked more than $395 billion out of stock mutual funds, according to the Investment Company Institute. In contrast, more than $775 billion has been funneled into the perceived safety of mutual funds that invest in bonds. (Mutual funds that invest solely in U.S. stocks have seen outflows six straight years.) That trend of selling stock funds and buying bond funds has continued in 2012.

One Wall Street pro blames the exodus from stocks on the boom-bust, boom-bust roller-coaster ride investors have been on in recent years.

"American investors' appetite for risk has been beaten out of them by market volatility," says Walter Zimmermann, chief technical analyst at United-ICAP. He says sitting on bigger cash reserves is both "rational and warranted" so that people and businesses will be able to access much-needed funds on short notice if another severe credit crunch like the one in 2008 surfaces.

Martin Blank, 69, of Lake Worth, Fla., got out of the stock market after stock exchange computers went haywire in May 2010, causing the "flash crash." He used to own blue-chip names such as Procter & Gamble. But now he has 100% of his money in A-rated municipal bonds that deliver the monthly income stream he and his wife, Linda, need to fund their retirement. "I lost confidence in the system," Blank says.

In an attempt to sidestep market volatility, Ron McElhaney, Jr., a 48-year-old married executive recruiter with four kids from Savannah, Ga., says he doesn't invest in individual stocks anymore. He also says he's watching every dime. "Splurging is ordering take-out food once a week," he says.

Signs of shifting strategy

The ongoing flight from stock funds runs afoul of the historical relationship between stock market returns and fund flows. Historically, cash has chased returns. But this time not even the S&P 500's 108% gain since the bull market began in March 2009 has been enough to lure jittery investors back in.

Investors' overall exposure to stocks has also declined. The percentage of 401(k) investors in their 50s, for example, who have more than 80% of their account balances riding on stocks has dropped by almost half to 26% since 2000.

The preference for less risk is also evident in the recent gravitation toward big, established companies that pay out a chunk of their profits to investors in the form of dividends.

Michael Rethman, a marketing consultant from Honolulu, has loaded up on dividend-paying stocks such as cigarette maker Philip Morris, drug companies such as Pfizer and Johnson & Johnson, and toothpaste maker Colgate-Palmolive. Those stocks offer annual yields ranging from 2.4% to almost 5%. Dividend-payers are part of his "play-it-safe" trades, which also include investments in gold as well as income-generating deferred annuities that pay about 5% in annual interest.

The quest for safety is also illustrated by investors' willingness to buy 10-year U.S. government bonds that, when adjusted for inflation, actually have negative yields. Some investors are so committed to making sure they get their initial capital investment back that they are willing to lose money to do so. "Is there anything more risk-averse than this?" asks Jeremy Siegel, a professor of finance at the Wharton School at the University of Pennsylvania.

Numbers also provide evidence of risk aversion, says Don Luskin, chief investment officer at Trend Macrolytics. Apple, he points out, is the world's most valuable company, with world-transforming products and super earnings. Yet it is selling at just a slight valuation premium to the broad market. Investors are also piling into 10-year government bonds and are earning just 1.6% on their money, less than the core inflation rate of 2.1%. Similarly, analysts' profit estimates for S&P 500 companies are at an all-time high, yet the price-earnings ratio for the broad market is roughly 13, which is about where it was at the market trough in March 2009.

"This tells you that investors are as scared as they were at the bottom of one of the worst bear markets in history," says Luskin.

The play-it-safe trend is best summed up by an investor poll conducted in August by TD Ameritrade: One out of three investors said they had taken on less risk over the past six months.

Where the fear came from

Why is safety in vogue?

"Better to be safe than sorry; it is as simple as that," sums up Sung Won Sohn, an economics professor at California State University.

The disconnect between investors' perception of the stock market and how it is actually performing has sparked a debate as to whether the era of risk-taking is over.

"Animal spirits (or the confidence to take risk) may come back, but there is no guarantee that they will," says Gregory Whiteley, a portfolio manager at DoubleLine Capital. "This type of risk-averse behavior is not easy to change. It's kind of a learned behavior that becomes ingrained."

The origin of the fear is now well known. A pair of 50% stock market drops in the 2000s. A real estate crash. Falling wages. Sinking confidence. And a severe recession that has cost millions of Americans their jobs.

The financial hit has been huge. The median wealth of U.S. families fell by a median 38.8% over the 2007-2010 period, according to the Federal Reserve's latest Survey of Consumer Finances.

Fewer jobs. Smaller paychecks. Less wealth. That dismal equation does not add up to a swing-for-the-fences investment mentality, says Charles Biderman, CEO of TrimTabs Investment Research.

"People … are not willing to take as much risk," says Biderman.

Uncertainty about the current state of the global economy also has given investors a fresh case of the jitters. Europe's debt crisis has still not been resolved, and many European countries are already in recession. China's economy has slowed suddenly, boosting fears of a more acute global slowdown. And the U.S. is facing a fiscal crisis of its own if lawmakers don't extend the Bush-era tax cuts or if they cut government spending too much too fast in an effort to reduce the deficit.

Computer-created stock market mayhem in recent years hasn't exactly boosted investor trust in the market, either. The flash crash in 2010 and the snafu at the Nasdaq stock market during Facebook's botched May 18 IPO have also given investors pause.

Ironically, playing it safe has not been a winning investment strategy the past few years, says Thorne Perkin, managing director at Papamarkou Wellner, an asset management firm that caters to wealthy clients and institutional investors.

"Since 2008, the cash trade has been the pain trade," Perkin says. The pain has been watching cash balances stay the same due to 0% interest rates while the stock market has doubled. Yet, even the wealthy clientele his firm caters to have raised their cash positions to anywhere from 20% to 40% of assets, he estimates.

The problem? "Everybody seems perplexed as to why the markets have been so buoyant," Perkin says. "With all the bad news overhanging the market, people have been left scratching their heads."

That uncertainty keeps investors cautious and on the sidelines.

Risk-taking will return

So is the era of investors swinging for the fences in search of big profits over?

"The age of risk-taking is not over, nor should it be. America was built on taking risks," says Anthony Sabino, a law and finance professor at St. John's University.

But Americans, Sabino says, must start taking more intelligent risks. "We should have learned that assuming real estate always goes up, that IPOs always flourish and that those promised double-digit returns are real — and not a Ponzi scheme — are foolish, foolish risks," he says.

So what will give investors the confidence to take chances with their money again?

Confidence in the future, mainly in the form of jobs and better pay, will provide a new foundation for investors to start building wealth again, Biderman says. "When you are making money, things are good," he says.

Perkin says risk-taking will return when individuals are done paying off debt and when investing gets back to basics such as valuing companies on their business fundamentals rather than worrying about whether Europe will implode or how the next government intervention in markets will affect asset prices.

Investors will return to the stock market when they realize playing it safe is keeping them from reaching their financial goals, says Timothy Fidler, a portfolio manager at Ariel Investments.

"Right now, people are reaching for safety," says Fidler. "Eventually people will need to reach for return again."