Corporate America has been lying for years

The poisonous fallout from the WorldCom collapse will further undermine the confidence of millions of homeowners, pension savers and small-time share traders in a financial system already shaken by scandals.

Phil Clements, managing director of Towry Law Invest said trust had broken down.

The WorldCom affair 'has damaged investor psychology. Normally at this point in the cycle you would expect investors to buy in expectation of an earnings recovery', Clements added.

'This time no one believes earnings. Corporate America has been lying for years.'

Further stock market falls will cut bonuses on with-profit investment funds for pensions and endowments, and bring charges on many bonds relied on by small investors for income.

Falling share prices will also undermine the financial strength of life insurance companies, increasing the possibility that the weakest will collapse and others will be taken over.

Insurance analyst Ned Cazalet said: 'A lot of these companies have loads of money in equities. That destroys solvency at a fantastic rate. It's all pretty miserable.

'The typical with-profit provider is probably showing a return of minus 6 per cent this year and they need to make 8 per cent or more just to keep their solvency.'

Most insurance company managers had no experience of running businesses in a falling market, said Cazalet. 'Stephen King is writing the next chapter for the life insurance industry.'

Many small investors are locked into the stock market through pensions and endowments that they are unable to cash in, or bail out, only if they pay large penalties.

Even for those who can rearrange their investments, there are few places to hide. Cash could be the investor's best friend over the next few years, according to David Hanratty of independent money manager Nelson.

He advised people in their last decade before retirement to assess how much they have in their pension fund now, what contribution they will be able to make in their remaining years at work and what income the fund is likely to give when they retire.

'If it's the kind of income they want, they should protect it by moving it into a cash fund,' Hanratty said. 'If there's enough already, why risk exposing themselves to market fluctuations?'

Most people were likely to find themselves facing a much lower income than expected. Hanratty said they had three choices:

· Carry on spending normally and reconcile themselves to a lower standard of living in old age.

· Ride out the market turmoil and hope for a recovery.

· Or spend less now and save more in their pension funds. Again he recommended that further contributions be put into cash funds, not shares.

His firm expects the price of bonds and gilts to fall sharply with any rise in interest rates. Hanratty said: 'To take one gilt as an example, we calculate the Treasury 5 per cent 2012 will fall by 16.4 per cent if interest rates rise 1 per cent.'

This is less of a problem for investors who have longer to go until retirement. They should regard the current state of the market as an opportunity to buy cheap and contribute as much as possible. The hefty tax relief on pension contributions means basic rate taxpayers will also benefit from a 22 per cent discount, and higher rate payers from one of 40 per cent.

They should aim to spread their money between the different asset classes, although those in occupational schemes may have little choice. The easiest way to do this is through a managed fund, but Hanratty warned that many of these had invested too much in equities in recent years; he preferred a more balanced approach.

Millions of homeowners with endowments face a shortfall, but this could prove less of a crisis than many originally believed.

Hanratty said: 'The first thing to do is ask your insurer for a prediction of what the endowment is likely to pay, so you know how much money you'll need to find.

'In many cases, people will find they have a shortfall of say £10,000 on a £60,000 mortgage. In the worst case scenario, where they have to continue paying off an outstanding £10,000 loan, at current interest rates this will only cost about £45 a month.'

And in most cases the properties concerned will have shot up in value since the endowments were first bought.