401(k) plans provide most investors an easy way to save a considerable amount of money for retirement, which is why it is not surprising to see many investors with a majority of, if not all, their assets in their 401(k) plans. So, if you are within 10 years of retiring and all of your retirement assets are in a 401(k) plan, how do you apply the Ten Year Rule?

The Ten Year Rule states any money you need within the next 10 years to cover spending needs should be placed in fixed-income investments held to maturity to protect principal. However, 401(k) plans generally have limited investment options, usually 15 to 20 funds. Buying fixed-income investments, such as bonds or CDs, isn’t an option unless you have a self-directed brokerage option in your plan.

With circumstances like these, I recommend individuals who are within 10 years of retirement and have their assets tied up in a 401(k) plan to begin shifting the money needed to cover spending needs in retirement to bond funds offered within their plan. The reason is that this money should be protected from the volatility of the equity markets. You want an investment that will keep pace with inflation to protect your purchasing power; therefore, achieving high returns is not the goal. Bond prices may fall under some market conditions, but they generally don’t fall as far or as often as stocks.

Ideally, you’re looking for a bond fund that uses U.S. Treasury bonds as the underlying investment. Bond funds are generally categorized by the duration of the underlying bonds, which gives you an indication as to how sensitive the bond fund investment is to interest rate changes. Long-term bond funds carry more interest rate risk than short- to mid-term bond funds.

Bond funds do not have a maturity date, and your shares may be worth more or less than you paid for them when you sell. You can lose money in a bond fund. Bond prices tend to move in opposition to stock prices. When the market is rolling along reaching new all-time highs every week, bond returns tend to be relatively low. As economic conditions make companies more profitable, that can lead to inflation, causing the Federal Reserve to increase interest rates hoping to slow inflation. Rising interest rates cause existing bond prices to fall; therefore, if you have a bond fund that is holding bonds at a lower interest rate than what is currently being issued, the value of the bond fund will likely decrease. The underlying investments in a bond fund are constantly maturing or being sold with new bonds being added. As interest rates change, the value of the bond fund can increase or decrease. This is why it is nearly impossible to match the investment in a bond fund to your exact liquidity need.

All that said, bond funds can offer a more predictable return than stock mutual funds. With bond funds, you should be able to withstand a surprise 20 percent market drop a few months before you need to cash out. When investing in individual bonds isn’t an option, bond funds can be a good choice.

I recommend avoiding high-yield bond funds because these often carry an “equity-like” risk profile — not a risk you want for money that you’re trying to protect. Target-date funds take control of your allocation out of your hands, and you want to retain as much control as possible to ensure your portfolio fits your specific needs. If retiring within the next 12-24 months, it would also be prudent to may also consider a money market fund option within your 401(k) to help protect short-term liquidity needs.

William G. Lako, Jr., CFP®, is an Executive in Residence at Kennesaw State University’s Coles College of Business and a principal at Henssler Financial and a co-host on Atlanta’s longest running, most respected financial talk radio show “Money Talks” airing Saturdays at 10 a.m. on AM 920 The Answer. Mr. Lako is a CERTIFIED FINANCIAL PLANNER™ professional.


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