As millions of Americans pour money into mutual funds at a record rate -- nearly $1 billion a day -- concerns are growing that the funds are bringing new risk to the savings of many people and instability to the markets in which they invest.
A whole generation of savers, seeking alternatives to the 2 and 3 percent returns available at banks, is being transformed into investors.
Since the start of the current bull stock market, at the end of 1990, more than $450 billion has poured into mutual funds -- which include stock, bond and money-market funds -- bringing their total assets to nearly $1.8 trillion.
But as the money mounts, so do the concerns.
In large part, people putting their money into mutual funds are middle-income and often first-time investors -- betting a larger part of their savings on increasingly uncertain and unstable markets. One in every four American homes invests in mutual funds and nearly half of all fund owners earn less than $50,000 a year.
"Mutual funds are becoming increasingly responsible for people's savings," said Arthur Zeikel, president of Merrill Lynch Asset Management, the nation's second-largest mutual fund group. "This is a cultural change. There are so many unknowns. Given the huge flow of dollars, more of these people's savings will become more volatile and less stable."
Most of the money for mutual funds has come from the banking system. Nearly $350 billion has been drained from banks since mutual funds took off. And unlike bank deposits, which are government-insured and guaranteed never to lose a penny, mutual funds are bets on the far riskier financial markets, where there is no certainty that investors will ever see all their money again.
There are now twice as many mutual funds -- about 4,300 -- than stocks listed on the New York Stock Exchange, and the demand for these funds has brought many more into existence, 1,000 in the last year alone. Mutual funds are the biggest buyers of municipal bonds and are an important source of capital for corporate America and to emerging companies, and they provide billions of dollars to the home mortgage market.
But on Wall Street, the worry is growing that mutual funds have become the gorilla of the stock market. Statistics compiled by Laszlo Birinyi Jr., head of his own market analysis firm in Greenwich, Conn., show that the major reason for large price changes in the stock market in recent months has been investments of mutual funds, pushing up prices, rather than the fundamental health of the economy or of the companies whose stocks are traded.
During the 1980s, the stock market was propelled by two dominant players -- pension plans investing on behalf of future retirees and corporations buying back their own stock through leveraged buyouts and takeovers of other corporations.
But that has changed since 1990, as mutual funds have invested nearly $140 billion in the stock markets. Mutual funds account for as much new money into the stock market as from pension funds and individuals combined.
While mutual funds account for about 10 percent of all stock ownership, they account for 30 percent of the trading volume on the New York Stock Exchange, Mr. Birinyi said, and, on hectic days, for more than 40 percent of all trades.
This high volatility results from a troubling aspect of mutual fund behavior: Unlike pension funds and individuals, which tend to buy and hold, mutual funds are generally short-term traders. Pressured by yield-hungry investors, mutual funds are more prone than pension funds or individuals to sell a stock when it begins to drop and buy those on the rise -- lest they miss the latest trend and investors flee.
"Funds jump in and funds jump out of the market," Mr. Birinyi said. "This is creating a major degree of stock volatility because all these funds are doing it together. Funds face real pressure on daily performance and this leads to a great deal of short-termism."
Adding to this is the fickle nature of many mutual fund investors. Panicky shareholders can overwhelm a mutual fund with redemption orders, forcing fund managers to sell shares -- even if they do not think it is wise -- to raise cash.
Market analysts worry that investors' demands can force more stock sales, pushing down stock prices and fueling the demand for more redemptions, promoting a destructive downward spiral.
"I worry about 1-800-redemption," said Richard Hoffman, chief investment officer at Cowen & Co. "In the old days, an individual stock buyer would go to a broker, who would be a buffer and slow the process down. Now, if the market hits an air pocket, they can run helter-skelter and take the investment decision-making out of the hands of portfolio managers by overwhelming him with redemptions."
Mutual funds are, in effect, pools of capital that enable an individual investor to divide a single investment among many stocks or bonds, which can be safer than choosing one particular company to invest in.
The shift into mutual funds has not gone unnoticed: Congress is holding hearings examining this explosive growth. While this inquiry is described as a "checkup" of an otherwise healthy patient, it marks the first time in recent years that Capitol Hill has examined the industry.
Mutual fund leaders have been calling on Congress to increase inspections by the Securities and Exchange Commission to protect an industry that, so far, has been tightly regulated and free from scandal -- despite infrequent inspections.
The industry fears that the explosive growth may entice marginal players into the business, bringing shoddy products and scandal with them.
Industry executives are also worried that the average investor who is benefiting from -- and causing -- the mutual fund boom, may be in for a rude awakening when the markets turn sour.
"Any negative publicity about any fund could have a chilling effect on the warm feelings that the investing public has for the mutual fund industry today," Mr. Zeikel of Merrill Lynch said. "For this reason, SEC resources should be increased."