James Carville was one of former President Bill Clinton’s top advisors. He famously once said: “I used to think if there was reincarnation, I wanted to come back as the President or the Pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everyone.”
It’s been easy to get caught up in the excitement of the stock market the last few months. Your year-end 2020 company 401(k) retirement plan account value was very likely an all-time high.
While everyone else is watching the stock market, individual company 401(k) retirement plan participants have to remember they also own bond mutual funds. Especially those popular target date mutual funds.
The current direction of long-term interest rates is threatening. Do you have a principal preservation strategy for your 401(k) bond mutual funds if interest rates rise much more quickly than expected?
My individual company 401(k) investment advice clients pay me to not be surprised by sudden losses in their retirement plan accounts. Here is part of the bond market logic I have shared with them recently.
The last time interest rates moved up dramatically was in the period from June 2016 to October 2018. During that period, the 10-year U.S. Treasury yield rose from about 1.5% to 3.15%. Bond mutual funds invested in long-term Treasury’s and investment-grade corporate bonds dropped by more than 18% and 8%, respectively.
When you invest in a stock market mutual fund, the price of the shares of those mutual funds rise and fall with the fortunes of the stock markets. Bond mutual fund prices rise and fall inversely with the direction of interest rates.
When interest rates go up, the value of your bond mutual funds goes down.
Interest rates are too low to produce any amount of meaningful long-term investment gains from bond mutual funds going forward. The long-term reward risk of rising interest rates is not in your favor.
Diversification? Go ahead and diversify all you want to or need to. No amount of diversification is going to save your company 401(k) retirement plan account value if interest rates keep going up.
In fact, the higher percentage of bond mutual funds you own—in your diversification efforts—the more 401(k0 principal you will lose.
Let’s do some quick math to figure out the potential risk to your company 401(k) bond mutual funds. The 10-year U.S. Treasury bill would fall in value by around 9% and the 30-year U.S. Treasury bond would fall in value by around 21% if interest rates rose by 1%.
The 10-year U.S. Treasury rate has already risen by about 0.6% from Aug. 4, 2020 to Jan. 15, 2021. This rise in interest rates has not yet been reflected in your company 401(k) retirement plan account statements due to the rise in stock market prices.
If interest rates continue to move higher, the rise will eventually be front page financial news. By that time, it is too late. Your bond 401(k) mutual funds will have moved quickly and dramatically down in price.
Now is the time to be proactive. Understand the percentage and duration of U.S. Treasury and corporate bonds you currently own in your company 401(k) bond mutual funds and target term mutual funds.
Sorry, but I just took all your excuses away for not paying closer attention to your bond mutual funds going forward. You have been warned.
Ric Lager
Lager & Company, Inc.
