Such an investor could create a portfolio which had less risk but higher expected returns. This is where enhanced index investing is so beneficial. An enhanced index investment is riskier than an index fund investment but may well be less risky than a portfolio that only contains a few stocks because the index is well diversified. The investor gets higher expected returns because of the enhancement and pays a price in risk relative to a straight index fund, but takes on less risk than with many undiversified portfolios. My research shows that individuals tend to sell stocks in declining markets.
Institutions take up the slack by buying that stock from the individuals.
Therefore, when the market is down and we are in a recession, institutions have about the same fraction of their holdings in stock as they do at peaks, but individuals have a much smaller allocation to stocks at economic recessions than they do at peaks or in normal times. This is important, I feel, because research shows that the stock market's expected return is the highest when times are bad. Therefore, what we see is individuals getting out of the stock market exactly at the time when the expected market return is the highest. However, I do not suggest that this is necessarily a mistake on the part of individuals. It may well be rational for them to play it safe in recession.