'Safe' Strategies Can Be Their Own Risks
Inflows during the past couple of years have shown that as investors grow risk averse, they "pile into very conservative investments," Bar-Or says. This has been a worrisome trend because younger investors pay an "opportunity cost" for doing so and miss out on the higher returns equities provide.
Older investors can also suffer from being overly stock averse.
"When people turn 65, almost magically at that point they should be at 100% fixed income," he says of conventional wisdom still offered by many advisers. "But people quite easily can live 20 years beyond that point, and that is a long time horizon to be switching to fixed income and depriving themselves of potentially higher returns."
Being all in on fixed-income plays may also prove detrimental in the current market environment."Given the prevailing interest rate environment, with rates being very low, it means that these people are jumping in and potentially locking in relatively low yields, which is going to hurt them because they won't get as much income as they might otherwise have hoped," Bar-Or says. "The double whammy of that is that they get relatively low returns in the near term, but in the longer time horizon it is likely that interest rates will go up. When they do, all the people who are holding fixed-income instruments in large quantities will potentially see value decline." As interest rates rise, some of these bond funds will roll over into newly issued instruments that will have higher returns. "There will be some ability by these investors to then subsequently pick up a higher yield in returns, but along the way they probably take a big capital gains hit," Bar-Or says. "Or, if they are locked into low-interest-paying instruments for the long term, it will be a while because they actually roll over into higher-paying instruments as well." For those who shy away from bond funds as being too risky or volatile, picking individual securities is an approach with its own dangers, particularly from a lack of diversification. "It could lead to potentially disastrous results," Bar-Or says. "If they happen to pick the bond of a company that subsequently defaults, they could lose a large chunk of their nest egg."
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