The correlation between interest rates and bond mutual fund prices is the least understood investment management concept. I can think of a handful of people I have met in Minnesota that understand this key relationship.
Bond mutual fund prices are directly connected to interest rates. Bond mutual fund prices will rise as interest rates fall. Bond mutual fund prices will fall as interest rates rise.
Not all bond mutual fund options in any company 401(k) retirement plan account are created equal. There are slight exceptions. But the connection between bond mutual fund prices and the direction of interest rates is a law of the investing universe.
Interest rates have been falling for many years. Bond mutual fund investors have not had to make investment management decisions on their bond mutual funds.
In the investment business, nothing lasts forever. Interest rates are now rising dramatically. Bond mutual funds are not safe investments when interest rates rise.
I am not talking about dividend yields paid by bond mutual funds. Dividend yields are mostly unaffected by rising interest rates. Eventually bond mutual fund dividend yields will rise after interest rates rise.
Individual company 401(k) retirement plan participants buy bond mutual funds for safety of principal. Bond mutual funds were widely promoted by company retirement plan sponsors and company retirement plan providers after the last two great stock market declines.
Bond mutual funds are promoted as safe and steady income investments that would give your investment principal back any time in the future. Who does not want safety and income in their company 401(k) retirement plan account?
The investment reality is that bond mutual funds do not provide safety of principal when interest rates rise. If interest rise, and keep going up, you will lose far more of your bond mutual fund principal than what you are being paid in dividends.
Know how much exposure you currently have to bonds in all the mutual funds you currently own in your company 401(k) retirement plan account. Only take the amount of interest rate risk that you are comfortable with.
What good is a 4% dividend if you lose 10% of your bond mutual fund investment?
Ric Lager
Lager & Company, Inc.
