Bonds have a place in retirement plan portfolios. However, recent research suggests that many 401(k) plan participants may have some misperceptions about what that place is and how bonds perform under various market conditions. In view of this research, taking the pulse of your 401(k) participants might be a prudent thing to do.
What the Research Says
The research, from State Street Global Advisors’ (SSgA’s) latest defined contribution plan participant survey, shows that overall, most investors have recovered from the 2008-2009 financial crisis, in which many saw their 401(k) accounts drop by as much as 40% or more. Five years later, nearly half (49%) of the participants surveyed consider themselves in “somewhat” or “much” better shape than they were previously.
Participants also appear to be more reconciled with the inevitable ups and downs of financial markets. Given a choice of carnival ride metaphors to describe saving for retirement, about half of surveyed participants identified with a Ferris wheel (alternative choices included roller coasters and bumper cars). The Ferris wheel choice was most prevalent among older investors who likely have witnessed more than one market meltdown.
Still, the SSgA survey revealed a shift in participants’ mindsets toward a more conservative posture. The proportion of 401(k) plan participants (about half) who reported investing more conservatively today than they did five years ago outweighed those who reported investing more aggressively by a 7-to-1 margin
Shift in Mindset
One troubling survey result is the general lack of knowledge about bonds. Generally, bonds can help younger participants diversify their 401(k) plan portfolio, while older plan participants may use bonds as a small, but stable, income. However, inflation threatens bonds’ returns by reducing interest and principal payments.
When participants were asked to identify the perceived benefits of bonds, only about half picked “lower risk than stocks.” About 40% of respondents believed bonds provided a better portfolio diversification and only 30% said they reduced volatility. “The relative dearth of participants identifying these characteristics suggests that many people do not fully grasp the function of fixed income (bonds) in a retirement portfolio,” survey analysts concluded.
What many participants appear not to understand, SSgA believes, is that a high allocation to bonds constrains a portfolio’s capacity to offset the effects of inflation and “generate the growth needed to provide for sufficient retirement income.”