Over the last few weeks, several of the most reliable inflation metrics are clearly showing the beginnings of a sustained inflation rate rise. As a reminder, inflation measures price increases in consumer goods and services.
Inflation is the biggest threat to bond mutual fund investors. Remember the definition of a bond. Bond holders receive fixed coupon and principal payments. Higher inflation rates threaten to erode the value of those fixed-income payments.
When inflation rates rise, bond mutual fund prices fall. The early stages of this basic law of economics began last month.
Part of the problem with rising inflation rates is the historic amounts of fiscal and monetary stimulus policies from Central Banks around the world. These efforts increase consumer spending which often contributes to rising inflation rates.
One key question that will have a huge impact on the direction of bond mutual fund prices is how the Federal Reserve reacts to higher prices or higher inflation.
Historically, the Fed has tried to control rising prices by raising short-term interest rates. To date, the Fed has stated they will wait longer to react. So, the Fed is playing a game of chicken with the early stages of sustained inflation rates.
And your target date and bond mutual funds are caught in the middle.
I don’t pretend to know your long-term investment objectives with your company 401(k) mutual funds. So, my comments about inflation and bond mutual fund prices may not be suitable for your situation.
I do know that the investment management strategy for your 401(k) savings does not include losing a surprising amount of principal in your bond or target date mutual funds.
Don’t think your bond mutual funds are exempt from principal loss. And don’t think your bond or target term mutual fund manager has some magic formula that will prevent bond market losses in your 401(k).
You can place the statement that bond prices fall when interest rates rise in the same category as the sun rises in the east and sets in the west.
Higher inflation and rising interest rates always win. When, not if, those conditions persist you will lose money in your 401(k) owning bond and target term mutual funds.
Do you own a target date mutual funds now because you never took the time to identify the best stock market mutual funds on your 401(k) menu?
Do you own a bond mutual fund now because you read an article on the merits of “diversification” in Money Magazine several years ago?
In either case, your target date and bond mutual funds are in the early stages of “not working out well” in your company 401(k) account. You have been warned.
Ric Lager
Lager & Company, Inc.
