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'Safe' Strategies Can Be Their Own Risks

BOSTON (TheStreet) -- Market volatility and a lingering hangover from the recession has left many investors uncertain what to do when it comes to long-term strategies such as retirement plans.

For many, the reaction is to run away from risk and into the seemingly safe confines of conservative investments -- bonds, cash and fixed-income strategies. The flight to "safety," however, can bring about some unintended threats to the long-term success of 401(k) or IRA portfolios.

It's good to be safe in your investments, but don't be so safe that your approach becomes a threat itself to the long-term success of a 401(k) or IRA portfolio.

What's in a name
For some investments, being branded as "conservative" or "low risk" is not much more than marketing, says Yuval Bar-Or, an adjunct professor of finance at Johns Hopkins University's Carey Business School and author of Play to Prosper: The Small Investor's Survival Guide (The Light Brigade, 2010).

"This is a great time to be pitching stuff that is called conservative because people are so scared from what happened to them," says Bar-Or, who specializes in the study of decision-making in the context of risk. "When you talk about conservative investments, it is important to note whose definition you are using. Who inserted the word 'conservative' into the investment? One can come across something with a formal name that says 'conservative' that is not as conservative as perhaps a naive investor might think. There is potential for being misled, or misleading one's self, by focusing on the word."

He points out that mortgage-backed securities were considered conservative investments -- at least until the financial mayhem of 2008 proved otherwise.

There is also the belief bonds are safer than stocks, and that fixed-income funds always mitigate risk.

"But that conservative fund may very well hold junk bonds, making it far less safe than one might initially assume," he says.

Investors may also be disheartened to learn that some funds pitched as conservative may be dabbling in derivatives to inflate performance.

Sometimes managers simply "make mistakes" and end up with "exposures they didn't intend," Bar-Or says. But there are also situations where a fund may not be performing well and managers "battling to get back to even may purposely inject more risk."

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