I hope you made some good money in bonds last year, because it was not a good year for all bond funds. Through November, Bill Gross’s Pimco Total Return Bond Fund, perhaps the most widely held bond fund in 401(k)s, underperformed 90% of its peers, according to Morningstar. Morningstar estimates outflows of $3.6 billion through November. Jeff Tjornehoj, senior analyst at Lipper, expects moderate outflows of around $200 million from the Pimco fund for December, marking the first outflow in a calendar year since the fund’s inception in 1987.
Many 401(k) participants suffered in 2011 with their Pimco Total Return Bond Fund position. I’ve spent countless hours reviewing investment options in 401(k) plans and can tell you, when it comes to bond fund choices, it is slim pickings in far too many plans.
When picking funds in your own 401(k) plan, you want to pay attention to a bond fund’s sensitivity to interest rates—measured by its duration. The bond’s duration is an approximation of the percentage decline in its value for every 1% increase in interest rates. The smaller the duration, the less sensitive a fund is, and therefore the less risky in terms of interest rate fluctuations. As of November 30, the Pimco Total Return Bond Fund’s duration was 7.46—meaning that a 1% increase in interest rates would correspond to a loss of approximately 7.46% of the fund’s value. The most recent five-year Treasury auction was at a record-low 0.88%, so over time, expect rates to go up.
If your investments are not restricted to a list of funds in a 401(k), my preferred bond strategy for you is to own the bonds outright and ladder them. You can control the average maturity and when rates go up hold them until the principal is returned. And if you’re stuck with only a handful of bond funds to choose from, stick with the high-quality, short-maturity ones.
OK, so interest rates have pretty much nowhere to go but up. But please, please don’t let this deter you from owning bonds in your portfolio. Make it a New Year’s resolution to have a solid short-term bond component in your portfolio.