Tip for 401(k) Investors Worried About Rates: Tweak Bonds

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By David B. Brandolph

Dec. 1 — If you’re a 401(k) plan investor worried that Trump administration economic policies may trigger a jump in interest rates, you may want to reduce the risk of your bond fund holdings.

Financial advisers typically recommend that 401(k) plan participants bulk up on bond or other fixed income investments as they near retirement. This is needed, they say, to offset stock market risk.

Enter the Trump administration, with stated designs to cut taxes and spend big on infrastructure ventures. If implemented, some believe these projects could stimulate the U.S. economy and lead to rising interest rates.

Investment markets may already be signaling that they expect interest rates to rise. Since the Nov. 8 election, U.S. stock markets have rallied while bond prices have dropped.

Plan investors with significant bond allocations may want to take notice, as bond prices typically decline when interest rates rise.

Such investors may want to “examine the average duration of their bond investments to see if they are taking too much risk,” David Blanchett, head of retirement research with Morningstar in Chicago, told Bloomberg BNA.

Not everyone, however, believes that plan investors need to be taking action to reduce bond investment risk.

“Most investors should be looking at the long-term,” and not be making any changes based on recent concerns about economic policy or interest rates, Francisco Torralba, senior economist at Morningstar Investment Management in Chicago, told Bloomberg BNA.

“Even if we know that fiscal stimulus spending is coming,” the country’s economic policy could change with the mid-term elections in two years or with the presidential election in four years, he said.

“Any fiscal boost done today may be short-lived,” Torralba said.

Reducing Average Bond Duration

A bond or bond fund’s average duration measures the interest rate sensitivity of the bonds held in the fund and can typically be found in the fund’s literature.

Long-term bond funds typically have a duration of 10 years or more, while intermediate-term funds have a duration of five or six years, Blanchett said.

If interest rates rise by 1 percent, a fund with a duration of 10 years will lose about 10 percent of its value, while the price of a fund with a five year duration will drop by about 5 percent.

Investors worried about a significant interest rate increase should consider moving their bond investments to stable value or money market funds, Blanchett said.

They may also want to reduce the effective duration of their bond investments by moving to short-term duration bond funds--those with durations of one year or less, he said.

Rate Increases Already Priced

"Most investors don't understand how the bond market works, beyond knowing broadly that if rates go up, prices go down and vice versa," Joe Goldberg, director of retirement plan services for Buckingham Asset Management in St. Louis, told Bloomberg BNA.

However, the bond market as a whole has expectations, like the stock market, and if the market expects rates to rise, that will already be priced into bond prices today, he said.

That's why it's usually not a good idea for plan investors to sell their bond fund investments in anticipation of rate increases, he said.

However, if interest rates were to rise more than what the market expects, there could be a more dramatic decline in prices and bond investors could rush to sell their bond fund holdings, he said. This could force funds to sell their holdings to raise the cash needed to pay fleeing investors. In that event, bond fund investors could be negatively impacted, particularly among funds with longer-term durations, Goldberg said.

To avoid such a scenario, Goldberg said that risk-averse participants could decide to move their current bond fund assets to funds with short-term durations of between one to three years.

No Reason to Act

Plan investors may also be fine if they sit tight and don’t make any portfolio changes.

The setting of interest rates depends on a lot more than the latest economic stimulus program, Torralba, the economist, said.

In fact, the global supply and demand of capital and monetary policy are much more important factors in determining these rates, he said.

Furthermore, it’s unlikely that events of the last few weeks will dramatically change the trend of declining interest rates that has been in place for three decades, Torralba said.

Demographics and worker productivity have played a key role in keeping rates low, and these forces take a long time to unfold and reverse, he said.

To contact the reporter on this story: David B. Brandolph in Washington at dbrandol@bna.com

To contact the editor responsible for this story: Jo-el J. Meyer at jmeyer@bna.com

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