Paul Smith, a retired attorney in Virginia, lost 30 per cent of his US$401,000 retirement savings during the financial crisis.
He shifted to bond funds from stocks and now holds at least 60 per cent of his savings in fixed income. While payouts from some of the bond funds barely keep up with inflation, Smith says he's worried about another decline in stocks.
"My wife and I are very risk averse," the 64-year-old says. "Frankly, the volatility in the market is a concern to us."
Investors like Smith have poured US$982 billion into US bond funds from January 2008 to the end of August while pulling US$439 billion out of equity funds and sacrificing a 115 per cent rally in stocks for the perceived safety of bonds. Money managers and fund executives such as Pimco's Bill Gross and BlackRock's Laurence Fink are warning that the flight to bonds leaves savers exposed to new losses once interest rates rise, a risk many retail clients aren't aware of.
While investors who hold bonds until they mature don't lose money unless the issuer defaults, mutual funds and other holders who trade the securities to maximise yields can suffer if interest rates rise. Long-term Treasuries have had almost as many losing years as stocks in the past 85 years, and fared worse than equities when adjusted for inflation.
"The greatest irony is the perception of safety in a fixed-income security," says Mitchell Stapley at Fifth Third Asset Management. "As the head fixed-income guy here, when I look at bonds today, they scare me."
In 1994, when the US Federal Reserve raised its target rate six times, bond funds on average lost 4.6 per cent. Investors pulled US$62.5 billion from the category that year, compared with deposits into equity funds of US$114.5 billion, according to the Investment Company Institute, which represents the mutual-fund industry.
