One of the things I have seen in 401k plans is a scale measuring risk from low to high and the mutual fund choices available in the plan placed in the approximate location on that scale. One example of the progression from low risk to high risk is often represented as follows: cash or money market funds; Bonds; stocks ~ large-cap value ~ large-cap growth ~ small-cap value ~ small-cap growth ~ foreign ~ emerging markets.
Now let’s focus on the “low risk” side of the scale. This will be important as we look at the other products offered in the plan. Cash and money market are fairly self explanatory. There is a common misconception with the bond fund however. This asset class is typically represented a being low risk ~ the implication being that it is safe ~ although that is not always the case.
For a bond investor interest rate risk is easily managed by holding the bond to maturity ~ when they will get ALL their money back.
In a bond fund however, the investor NEVER has a stated maturity date and there is no guarantee, or even promise, they will get all their money back. The bonds inside the portfolio will mature and the issuer will pay as promised; but, that is not how it plays out for the bond fund investor. So the bond fund investor, cannot escape the interest rate risk and there is never a promise that they will get all their money back.
The early retirement planning question has to be: are interest rates more likely to rise or fall from the time of my initial investment to the time I expect to cash in my retirement account?
If I am looking at a low interest rate environment when I put my money to work and have ten plus years to retirement how likely is it that rates will remain the same or go lower? Should they go higher, I will not get the return of my investment.
Are bond funds low on the risk scale? The answer depends on your view of interest rates
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