Understanding Bonds

What Do Your Plan Participants Know About Bonds?

Bonds are a key part of retirement portfolios. However, recent research suggests that many 401(k) plan participants may have some misperceptions about what that part is — as well as how bonds perform under various market conditions. In view of this research, taking a closer look at your 401(k) participants might be a prudent thing to do.

What the Research Indicates

The research from State Street Global Advisors’ (SSgA) 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. Only 24% consider themselves “somewhat” or “much” worse than they were.

Participants appear to be more attuned to the inevitable ups and downs of financial markets. When given a choice of carnival ride metaphors to describe saving for their retirement, about half of the participants identified with a ferris wheel. (Alternative choices included roller coasters and bumper cars.) The ferris wheel was most common amongst older investors who’ve witnessed multiple ups and downs in the market over the years.

Still, the SSgA survey reported a shift in participants’ mindsets towards a more conservative position. The proportion of 401(k) plan participants (about half)  who reported investing more conservatively today than they did five years ago overwhelmed — by 7-to-1 — those who reported taking a more aggressive position.

Shift in Mindset

One troubling survey result is the overall general lack of knowledge about bonds. Generally, bonds can help younger participants diversify their 401(k) plan portfolio to help alleviate market risks, while older plan participants may choose to invest in bonds for a small, but stable stream of income. However, all participants must remain cautious as inflation threatens returns on bonds by reducing interest and principal payments.

Out of those asked to identify the perceived benefits of bonds, only about half of the participants chose “lower risk than stocks.” About 40% of the respondents believed that bonds provided better portfolio diversification and only 30% believed that they reduced volatility. “The relative dearth of participants identifying these characteristics suggests that many people don’t fully grasp the function of fixed income in a retirement portfolio,” survey analysts concluded.

SSgA believes that many participants in plans do not appear to understand that a high allocation of assets to bonds will constrain a portfolio’s ability to both offset the effects of inflation, and “generate the growth needed to provide for sufficient retirement income.”

What to Do

Plan sponsors should review their participants’ bond allocations and consider them in light of the participants’ ages. Based on this review, there may be an opportunity for some further enlightenment on the appropriate asset allocations for different age groups. In addition, plan sponsors should also encourage all plan participants to optimize asset allocations and continue to monitor and adjust them, as needed, as the participants approach and enter retirement.

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