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."

Opportunity cost

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."

Looking for a magic bullet

Throughout the financial crisis, target date funds came under considerable scrutiny when many of these retirement products lost a third or more of their value.

Despite a common understanding (or misunderstanding, as the case may be) that the glide path of these funds dialed down risk over time, many retirees and near-retirees were upset to find a higher than expected allocation to stocks. The "set-it-and-forget-it approach" led many to make incorrect assumptions about the level of risk they were taking on.

Though some funds did fail at their task, Noel Abkemeier -- a retirement actuary who specializes in guaranteed lifetime income products for Milliman -- defends their overall approach and calls some of the criticisms "a bit harsh."

Abkemeier, an active member of the

Society of Actuaries

, warns, however, that investors can't assume that any investment is guaranteed to be perfect for their needs at all times and in all markets.

"I think people think something like a target date fund is a silver bullet that is exactly molded to their needs and will never fail them," he says.

As for complaints about how some target date funds kept their holders invested in stocks until late in life, Abkemeir takes no issue with that strategy.

"You always have some life ahead of you, and there is always room for some degree of equity return," he says. "If it is diminishing over time, that's all very appropriate."


The push for "set it and forget it" investment strategies, or being sold into supposedly low-risk products, can sometimes lead to inertia and complacency.

"One an investor believes that he or she has been invested in something

safe, there may be a tendency to feel, 'OK, I moved everything to conservative investments, that means I can now breathe a sigh of relief, my anxiety is gone and I no longer need to maintain oversight of what's going on,'" Bar-Or says. "Investors should never become complacent. They should always be on top of things and be aware of what is being purchased in those funds and whether their adviser is actually doing what they are promising. Being complacent just opens the door for bad things to happen."


Even conservative, passive investments can be built with excessive or unnecessary fees, and investors should make sure they aren't paying too much for the peace of mind that comes with lowered risk. The compounding effect of those fees can severely cut into the size of a nest egg over 20 to 30 years.

There are plenty of conservative options that are well-diversified and carry low fees, Bar-Or says. Investors need to "invest in themselves" by doing the needed research to make sure they aren't paying more than they have to.

-- Written by Joe Mont in Boston.

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