Bond Fund Investors Beware!

Paul Smith, a retired attorney in Oakton, Va., lost 30 percent of his 401(k) retirement savings during the financial crisis. He shifted his money to bond mutual funds from stocks and now holds at least 60 percent of his retirement savings in fixed income. While payouts from some of the bond funds barely keep up with inflation, he’s worried that stocks could see another decline. “Both my wife and I are very risk averse,” the 64-year-old says. “Frankly, the volatility in the market is very much a concern to us.”

Investors like Smith poured $982 billion into U.S. bond funds from January 2008 through August while pulling $439 billion out of equity funds. Those investors missed out on a rally in stocks—as of Oct. 16 the Standard & Poor’s 500-stock index had gained 115 percent since March 2009. Money managers and fund executives are warning that the flight to bonds leaves savers exposed to a new round of losses once interest rates rise, a risk many individual investors aren’t aware of. “The greatest irony here is the perception of safety in a fixed-income security,” says Mitchell Stapley, chief investment officer at Fifth Third Asset Management. “When I look at bonds today, they scare the hell out of me.”