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Funds big on bonds risky when rates rise

| Sunday, Sept. 15, 2013, 9:00 p.m.

Taking the easy route with investing isn't feeling so easy.

A no-brainer approach to investing in 401(k)s, IRAs and 529 college savings plans during the past few years has been to choose an “allocation fund,” or a fund that takes you off the hook for making decisions. These single funds divide your money up into stocks and bonds. The idea is to turn your money over to a brainy fund manager and go on with life.

The fund manager pays attention to what you want for investments by adhering to the “conservative” or “aggressive” label you've chosen on a fund.

The surprise of the past few months has been that a “conservative” approach turned into the strategy most prone to losses. “Conservative” traditionally means that a fund manager puts more bonds than stocks into your fund. And while bonds are usually safer than stocks, that hasn't been the case lately.

The safest, U.S. Treasury bonds, have been losers. This year, the Treasurys that mature in 10 years have lost about 4 percent. The reason: Investors have expected interest rates to climb, and interest rates control gains and losses in bonds. During periods of rising interest rates, bonds become losers.

So from May through August, people with money in the average conservative allocation fund lost 2 percent of their money, Morningstar reported. That's not a crippling loss, but it has to be a shock for people who figured they were being safe.

Conservative allocation funds typically keep somewhere from 50 percent to 80 percent of your money in bonds, which makes them vulnerable in a rising interest rate environment.

Moderate funds hold about 30 percent to 50 percent of your money in bonds, which has meant lackluster returns from early May through August. Investors in the average moderate fund gained just 0.1 percent, Morningstar said.

Aggressive allocation funds did better than conservative ones. They gained 0.7 percent on average, according to Morningstar. Many keep 70 percent to 90 percent of an investor's money in stocks. Since May, the stock market gained about 3 percent.

The recent losses in conservative allocation funds don't mean you dump them and run — if you are saving for the future. But if a fund is full of Treasury bonds, and a parent has a college bill coming up, for example, it could be prudent to move some of the money into a money market fund for safekeeping.

Morningstar analyst Greg Carlson suggests that, when picking an asset allocation fund, investors make sure the fund manager is experienced and savvy about picking bonds. Many funds have pros picking stocks who are not as attentive to bonds. They might simply buy U.S. Treasury, rather than a mixture of bonds that provide more insulation in a rising rate environment.

Carlson notes that Dodge and Cox Balanced Fund is a moderate allocation fund that did better than most other moderate funds during the tricky May-through-August period. Other allocation funds that have savvy bond pickers, according to Carlson, are Pimco All Asset, Vanguard Wellesley Income, Vanguard Wellington, Janus Balanced and Fidelity Puritan.

Gail MarksJarvis is a personal finance columnist for the Chicago Tribune. Readers may send her email at gmarksjarvis@tribune.com.

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