In Flight to Safety, Savers Take a New Risk

By Sameepa Shetty
Columbia Journalism School C’13

For years, financial advisers have had to persuade investors saving for retirement not to take on too much risk. Although equities offer a larger payout on average over time, they are also more volatile, the conventional wisdom said, so a balanced portfolio of stocks and bonds was the best approach.

Recently, investors have taken that advice and ran with it. Today, fixed income investments like bonds make up the largest share of 401(k) plan assets in recent history, according to the Employment Benefit Research Institute, a Washington-based research group that has been tracking retirement fund allocation since 1996.

The problem is that even as savers were looking to curb risk, they may have unknowingly introduced more. This large-scale shift in asset allocation could actually weigh on 401(k) balances in two ways, investment professionals say. First, a portfolio without enough exposure to equities could leave investors short of their savings goals when they stop working. Second, too much money in bonds could leave retirees more vulnerable to an inevitable rise in interest rates.

Now, if investors continue to increase their exposure to bonds as they have been, a generation of risk-averse savers may have to either delay their retirement or face the prospect of a leaner life after work.

The Flight to Safety

Today’s average 401(k) plan looks markedly different than it did just 15 years ago. In 1998, the typical plan participant had about 28% of his or her portfolio in fixed income investments. In 2011, the last year for which data are available, it was up to 34%. Over the same period, the share of assets in bond funds, per se, more than doubled.

Those gains came at the expense of exposure to equities. The average 401(k) plan participant reduced investments in equity funds from 50% in 1998 to 39% in 2011.

“People were more concerned about preserving capital than the potential for growth in the equity markets,” says Judy Hastleton, a financial advisor who oversees more than $37 million.

EBRI President Dallas Salisbury says retail investors may have left equities because they could not tolerate the recent volatility. “Individuals cannot deal with the risk that (in theory) institutions sponsoring pension plans can,” he said in an email .

Bonds, on the other hand, have performed well over the last ten years. A dollar invested in long-term government bonds at the end of 2002 would have been worth $2.06 at the end of last year. A dollar invested in large company stocks over the same period would have grown to $1.99. (For small company stocks, it was closer to $2.69 in small company stocks.)

A Bubble on the Horizon

Although 2012 was a great year for bonds, fixed income analysts warn that 2013 may be less kind. Interest rates remain at historic lows and bond prices will fall if interest rates rise “It may be time to get selective in the bond market,” Jamie Stuttard, head of the international bond portfolio at Fidelity, wrote in the company’s 2013 global bond outlook.

Financial planners like Hastleton are advising clients intent on maintaining their fixed income exposure to stay at the short end of the yield-curve and diversify their holdings with corporate and high-yield bonds.

“Fixed income is not safe,” says Goran Hagegard, Managing Director of investment management at Stamford Conn. based Greenwich Associates. He says bond portfolios will drop in value if interest rates go up or if inflation rises faster than expected.

Some investors are already losing money because their bond holdings don’t keep them at pace with inflation, Hastleton says. The 10-year U.S. treasury yield traded between 1.3 and 2.9 percent throughout 2012, while inflation averaged about 2.0 percent. “I have seen my clients extending their work life past what they anticipated and cutting back expenses to save as much as they can for retirement,” Hastleton says.

The Risk-Averse Generation

Young Americans have become dramatically conservative in saving for retirement over the last 15 years. In 1998, 401(k) participants in their 20s put about 5 percent of their assets in bonds and 62 percent in equities. In 2011, the new group of participants in their 20s put about 7 percent of their assets in bonds and 33 percent in equities

Hagegard says this strategy is all wrong. “Why would you put any money in fixed income if you plan to retire in 40 years?” he says. “The best you can do is put money in equities and not look at it. Volatility is immaterial to you if your investment horizon is that long.”

For young savers, the consequences could be severe. “I think they are not going to be able to save as much as they are going to need in retirement” says Hastleton. Given the uncertainty around social security and other benefits, she says, “people in their 20s today need to be much more self sufficient than people in their 50s and 60s today, and high fixed income exposure won’t facilitate that.”

Stocks might in the long run. Prudential, the nation’s second largest life insurance company, said in its annual report that the long-term expected rate of return for equities would be over 9 percent, while the long-term expected rate of return for fixed income is a little over 5 percent.

Financial planners say 401(k) participants in their 20s should have at least 70 to 80 percent of their portfolio in equities. “If you have a good career path [and] are saving consistently for your retirement, you need to take on more risk,” says  Hastleton.

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