When fashions change, last year’s styles lose value. I learned that lesson when bell bottoms went out of fashion (probably before you were born). Fortunately, this change didn’t happen overnight, so I had time to ‘retire’ some of my treasured possessions and make room for the new styles.
Bond markets operate the same way, but the current environment triggers a more instantaneous revaluation of last year’s bonds. If all you consider is the price reductions some bond funds will incur as rates rise, then you will think of the glass as being half empty. But perhaps it’s more constructive to focus on the opportunity that rising rates offers a long term saver.
How to Think About Rising Rates and Your 401(k)
During times of volatility and bond market uncertainty, it’s worth noting that 401(k) investors shouldn’t worry too much about what level of income their bond funds provide. Any income produced by any fund within a 401(k) is going to be reinvested in the same fund, so whether a fund’s returns come from growth or income is not particularly important to a typical savings plan member.
For many of us it’s really the diversification benefits–not income production–that should be of concern. Most of us combine stocks and bonds so that we have different asset classes that balance each other out during periods of volatility. Professional managers construct balanced portfolios that combine stocks, bonds and other asset classes that seek to lower the overall risk of a portfolio. Short term downdrafts in one asset class are generally balanced out by rising prices in other asset classes.
It may be useful for 401(k) investors to look at how target date funds invest as a proxy for what professionals might suggest for participants of a given age. With few exceptions, these funds don’t shift money into or out of fixed income during times like this when interest rates are likely to rise. They tend to stay with longer term asset allocation strategies that take advantage of diversification to offer participants a reasonable level of return for the amount of time left before retirement.
As we all watch what the Fed does over the next several months and years, remember that some things go out of fashion quickly. Negligible interest rates? Personally, I’m so over them. I welcome a change.
Scott Dingwell is a Director in BlackRock’s Global Client Group where he serves on the U.S. and Canada Defined Contribution Team. He writes about retirement for The Blog.
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of December 2015 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader.
Investing involves risks, including possible loss of principal. The target date in the fund name designates the approximate year an investor plans to start Withdrawing money. The allocation to asset classes in each fund rebalances every quarter and becomes more conservative over time as investors move closer to the target retirement date.
Source: BlackRock Blog Retirement
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