Why Date Funds Can Be Riskier Than You Think
A set-and-forget portfolio is a simple and safe investment option. But don’t take “forget” too literally. It is still useful to know about your investments and what they do, and if you have invested in funds with a set date, you might want to get to know them better.
We’ve already written about the ease of use of date-based tools . Over time, they gradually invest more and more of your portfolio in bonds rather than stocks. The idea is to minimize your risk as you get closer to cashing out your investments, and bonds are considered a low risk option.
But finance professor Jay Ritter of Forbes warns that they can be more risky than you think:
Today, bond investors are at enormous risk if inflation rises and interest rates rise. Fixed-date funds that shift asset allocations from stocks to bonds expose older investors to this risk. In addition, the more money in bonds, the less diversified the portfolio. A portfolio heavily invested in bonds is not necessarily safer, even in the short term, than a more diversified portfolio. Since we have had low inflation for the past 30 years, in my opinion, investors have calmed down. Just as the rise in real estate prices in 1995-2005 lulls many mortgage lenders into thinking that real estate is not very risky, so the prolonged bull market in bonds lulls investors, making them think that bonds are safer than they really are. …
Fixed date funds are probably still a win-win bet because they are based on basic rules of thumb for diversification. But rules of thumb can vary, which seems to be Ritter’s point of view. While he does not suggest giving up funds with a set date, he does offer to protect your portfolio from inflation:
So how can you get a safer portfolio that reduces your exposure to equity risks and the risks of long-term bonds as you age? One way is to shorten the maturity of the bonds. Another way is to invest in inflationary bonds. Such connections exist. They are issued by the US government and are called Treasury Inflation Protected Securities (TIPS). Coupons and principal are automatically increased when the consumer price index (CPI) rises. In this way, a set date fund investing in TIPS reduces the inflationary risk that the portfolio is exposed to.
Read more in the rest of the article at the link below.