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In the context of investing everyone is concerned about the safety of their money. Only a crazy person would exchange their hard earned money for a piece of paper that is worth only what other people are willing to pay for it on a particular day – especially when that value has been known to drop as much as 40% within the matter of a few weeks. You’d be crazy to give your money away based on the hope it will come back with interest but then again the only way to make a reasonable return is to do just that.

One way to gauge how this paradox impacts investors is to examine the overall balance in money market funds over the past few years. This overall balance reflects assets in all types of accounts, including 401(k), IRA, brokerage and mutual fund. The total net assets in money market funds was $3.2 trillion as of the relatively rosy time of January 2, 2008. This figure spiked to $3.9 trillion roughly a year later – by which time money market funds were paying almost no interest but had with a couple of notable exceptions managed to avoid losing any money. Another year later (April 28, 2010), after one of the most impressive bull runs ever seen, money market assets had plunged all the way back down to $2.9 trillion. Did anyone get the license plate of the bandwagon? http://www.ici.org/pdf/mm_data_2010.pdf 

In a continuation of the contradiction that governs investing, 401(k) plans did not participate in the migration of a trillion dollars in money market assets. The charts that follow (courtesy of EBRI) show that assets in "safe" investments such as money market and stable value funds did increase as a percentage of the whole (from roughly 20% of plan assets in the bull market of 2007 vs. 30%+ at the end of the punishing year that was 2008). That increase, however, has more to do with the fact that the assets in these categories did not drop in the crash while just about every investment in equities dropped by 30% or more.

The paradox has layers as anyone crazy enough to send a portion of their income elsewhere with the hope that someone would one day be willing to give them more in return would also have to be rational enough to know that the best time to invest is when the stock market is down – not during or after a rally. What we should see is massive inflows into the equity portion of the market when it is down.

The reality of the inflows and outflows has consistently proved to be the opposite and it’s worth noting that much of the movement in and out of money market funds may be attributable to the guidance of the brokerage/investment advisor community. Brokers and advisors are still struggling to find footholds in the 401(k) industry but control much of the rest of the investing universe. Are investors paying additional amounts for advice that sells them out of the markets at the exact time they would be best-served by making additional purchases?

Whether they reached the markets on their own or through the guidance of others there is no doubt that many investors (outside of 401(k) participants) fled the stock market in 2008 and early 2009 because they were spooked by the crash. Many investors in this period had benefited significantly from at least some of the five straight years of positive returns that led up to the most recent collapse. Prior to that bull market these same investors had just gone through what was, at that point, one of the worst collapses that any contemporary investor had seen (2000 – 2002).

It is reasonable to assume that anyone investing in 2003 was well aware that the market could fall – and that the value listed on their statement could drop significantly. These investors went in with hope that the market would cooperate but with the knowledge that it had not for three consecutive years. When the market provided five straight years of gains these same investors knew deep down that it wouldn’t go up forever -- but were shocked when it dropped.

There are many out there infinitely more qualified to discuss the topic of behavioral finance. I can say from many years of personal and professional experience that investing appears to be the one place where we can change our very nature. All of us have a fight-or-flight response that controls to some degree how we will respond to a stressful situation. These hard-wired reactions are nearly impossible to overcome as they represent, for better or worse, our very nature. The wiring related to investing appears to be more transitory in nature as we collectively alternate between prize fighters (especially when the opposition is already down for the count) and professional retreaters (when our accounts take a few punches).

Prior to making an investment it’s probably a good idea to ask yourself why you are doing it and what you realistically hope to gain. Better yet, look back at how you responded to the past couple of crashes. If your previous investing decisions fit the definition of either irony or a paradox it’s likely not a good sign. If you are like most of us you may be better off tempering your expectations and your stock allocations on the way in to avoid bumping in to them when you are on your way out.

Marshall J. Cobb, CRSP, is president and founder of Cobb Retirement Solutions, LLC., an independent, fee-only firm offering qualified plan analysis and oversight exclusively to corporations and organizations. Cobb’s first-hand knowledge as a veteran representative of retirement plan vendors beginning in 1990 gives him a unique perspective as he advises his clients. Cobb runs his office -- based in Houston, Texas -- with employees and clients across the country