What's next for 401(k) investors?

There may be something to be said, it turns out, for inertia.

That's not usually a positive for American workers, but in recent weeks, inaction by some 45 million people who invest part of each paycheck in stocks – via 401(k)s or other retirement plans – have helped cushion a plunging stock market against a crash.

For many, a precipitous 1360-point decline in the Dow Jones Industrial Average in just 10 sessions (from July 8 to 19) represents the toughest test of resolve in their investing careers. The open question was whether the big losses, corporate accounting scandals, and lackluster profits would prove to be too much for this relatively inexperienced class of small investors. Fortunately for Wall Street, flight did not occur.

"There is widespread public inertia" by investors in contributory retirement plans, says Stephen Utkus, director of Vanguard's Center for Retirement Research. "Most 401(k) investors are doing absolutely nothing with their accounts. Typically, we've found that about 85 percent of participants tend to sit out a financial crisis."

Even after Friday's dive – when the Dow fell 390 points – Mr. Utkus predicted that when the year is finally over, only about 2 to 3 percent of all 401(k) assets will have been shifted out of the US stock market.

That means the $1.7 trillion tucked into contributory retirements plans – accounting for about 16 percent of US retirement investments – is acting as a sort of bedrock for the stock market. How long 401(k) investors will watch their nest eggs dwindle, though, is unknown – and signs of restlessness are becoming more evident.

A poll released last week by Zogby America found that most Americans (51 percent) said they were less likely to invest in the stock market because of the recent corporate business and accounting scandals. Half of investors who own 401(k) plans were also less likely to invest.

And at the mutual-fund firm Vanguard Group, in Malvern, Pa., the nerve-racking week of July 8 (when the Dow lost 7.4 percent of its value) did light up the switchboard, as worried investors began to shift some of their money out of stock funds and into bond funds, money-market accounts, and international funds.

By last week, though, Vanguard was "actually seeing a decline in the number of 'panic' calls" from its investors, says spokeswoman Rebecca Cohen. And throughout the market slump, she adds, the most radical step small investors have taken is shift their money within the financial markets: "They are not redeeming money and getting out of mutual funds."

Luis Fleites, an analyst with Cerulli Associates, a consulting firm in Boston, guesses it would "probably take a prolonged bear market lasting another year or so for investors to stop putting money into the [retirement] plans."

For now, he confirms, "monthly contributions continue to go into 401(k) plans and mainly into stock funds."

While such regular contributions into retirement plans eventually help offset market losses, blindly following the same course of action can be dangerous. Investors may miss out on the need to properly diversify their portfolios, says Utkus.

Unbalanced portfolios often develop in cases when employers match worker contributions with company stock. This was the situation Enron workers found themselves in when the company went belly up.

To offset a match of company stock, employees should steer their contributions into noncompany investments, such as a general equity fund, experts say.

Allocation is crucial. "If a person is a younger worker, say in their 20s or 30s, they need to have most of their 401(k) portfolio in equities, to ensure growth over time," says Utkus. If they are 15 to 20 years from retirement, he says they should have a mix of stocks, bonds, cash, and perhaps a guaranteed investment contract – a product with a fixed interest rate usually offered by an insurance company.

If they are older, or close to retirement, they will want to have a large allocation of fixed income products, as well as a money-market, to protect their gains. But even then, Utkus says, investors need some stocks for growth over time, since retirees now live well into their 80s and beyond.

Finally, financial experts warn investors of all ages against shifting entirely out of equities. By doing so, they are likely to miss the heady gains that usually come in the early stages of a recovery.