Podcast Center
Video Center
Webcasts
Resource Center
Events
April 22, 2013 at 09:31 AM
As a 401(k) plan sponsor, you try your hardest to do your best for your employees. You’re responsible for studying complex issues like investment theory and risk your own personal liability to make decisions in areas like this, that, quite frankly, you have not had formal training in. Yet you do. For the good of your employees.
And when decades of accumulated investment wisdom demands you accept the platitude that a good portfolio contains some balance of stocks and bonds, you accept it. Alas, unbeknownst to you, sometimes a bond is not a bond. Because of that, you risk being caught unawares – and you’re employees risk losing a sizable chunk of their hard-earned retirement savings.
What’s a plan sponsor to do? I leave answering this question to others (and they do it here: “Anticipating the Bond Bubble Burst: Protecting Your 401(k),” FiduciaryNews.com, March 19, 2013). I want to focus on the root cause of the problem.
Too many investors – including professionals who ought to know better – mistakenly believe bond funds are the same animal as bonds. Let’s cut to the quick: They aren’t. Bond funds are technically derivatively equity instruments composed of bonds. Don’t be confused by their underlying components. Bond funds are equities just like bank stocks, utility companies and real estate investment trusts are equities. (OK, OK, technically the latter is a trust, so let’s just say real estate sector funds.)
I choose those three readily accepted equity industry sectors with purpose. Most advisers rightfully classify them in the equity class. Like bonds, the movement of their price can be tied to the rise and fall of interest rates. Unlike bonds, they neither promise to pay a fixed income nor do they promise to return your original investment back to you in full upon a pre-determined maturity date.
That’s what bonds do. They pay a fixed income and they promise to return your original investment back to you on the pre-determined maturity date.
Bond funds, on the other hand, do the opposite of bonds. Like the aforementioned equity sectors, bond funds do not pay a fixed income, they pay a variable income. Like those similar dividend-oriented stocks we brought up, bond funds do not promise to pay you back your original investment in full, but subject you to the variegates of daily pricing changes. To whit, you can only sell your bond fund for what the market will bear. Unlike a bond, you cannot hold it through to maturity and recover your full initial investment.
