Retirement investors need patience as bond market wavers

Fran Kinniry, Vanguard Investment Strategy Group

Fran Kinniry, Vanguard Investment Strategy Group

With bond markets in turmoil, what is a 401(k) investor to do? Probably not much.

Retirement investors have enjoyed the best of both worlds these past two years: a bull market in both equities and bonds. But the bond market has been weathering volatility and sharp declines since late April, with prices falling and yields rising.

Bond experts are not certain that the bond party is over yet, but the recent volatility raises a question: should 401(k) investors take steps to protect themselves in the event of a sharp spike in interest rates and accompanying fall in bond valuations?

Experts do not think so. Unlike the world of active bond traders, retirement investing is a long-term game. Although the price of bonds moves in the opposite direction to their yield and hence fluctuates, principal always is returned if the bond is held to maturity.

And most 401(k) investors are in bond mutual funds for the fixed income portion of their portfolios, which are highly diversified and usually invested in intermediate (five-year) high-quality government and corporate bonds.

“If investors stay course and their holding period is longer than the fund’s duration, rising rates should be not much to fear,” says Fran Kinniry, a principal in Vanguard’s Investment Strategy Group.

Kinniry adds that the enduring low-rate environment has led retirement investors to change their view of the role bonds play in their portfolios. For a very long time, they saw bonds as an asset class delivering yield. But with such a low rate environment, the real role of bonds is to truncate or reduce equity risk, especially for older investors and retirees, who still may have 30 or 40 percent of their assets in equities.

Automation is another key factor reducing the drama of the bond market’s volatility.

About half of all 401(k) plans now offer one-on-one financial counseling, online advice or managed account services, according to Aon Hewitt, and roughly 10 percent of workers at those firms are taking advantage of the services. A bigger trend is the investor shift to target date fund (TDF) series, which follow predetermined asset reallocations based on a specified expected retirement date, with a shift toward income as retirement gets closer.

Longer term, a return to a higher-rate environment would be very positive for retirees, who depend on bonds and even certificates of deposit for income. They have been suffering through an extended yield drought ever since the Great Recession.

Vanguard’s Kinniry thinks rates ranging from 2.5 percent to 4 percent could be in the offing. “But we’re not seeing any signal calling for runaway bond yields,” he says.

Learn more at Reuters Money.

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