Investors may be overestimating certain risk factors and inadvertently taking on extra risk elsewhere to offset them, according to Morningstar.
“Risks seem to lurk everywhere you look—to the potential for rising bond yields to not-cheap equity valuations to political unrest throughout the globe,” wrote Christine Benz, director of personal finance at the research firm. “Even as it’s worthwhile to anticipate and mitigate the effects of those risk factors, there are some risks that investors are blowing out of proportion.”
First, Benz said relying on yield and income-producing securities may not be sustainable given today’s interest rate climate.
Specifically, those investors that need a higher yield than 2.5% to 3%—the average yield from most high-quality, intermediate-term bond funds—may need to “edge out on the risk spectrum” for higher yield, Morningstar said.
“Even as it’s worthwhile to anticipate and mitigate the effects of those risk factors, there are some risks that investors are blowing out of proportion.” –Morningstar. However, instead of taking on more risk, Benz suggested investors should “periodically tap capital from appreciated assets,” such as equities and lower-quality bonds. The rebalancing could also help lessen portfolio volatility.
Asset owners should also be careful to not overestimate the effect of rising rates fixed income, the report said.
“Investors have been sounding alarm bells about the risks that rising interest rates pose for bond portfolios for a good three years now,” Benz said. “But while interest rates did indeed bump up in the US last summer, jostling bond funds in the process, US yields have declined again so far this year and are lower today than they were three years ago.”
For a typical intermediate-term bond fund, a one percentage point rise in interest rates in a one-year period would incur only a 3% loss, Morningstar said, marking a smaller loss than one caused by volatility in equity markets.
Benz also said investors need not be too averse to international equities, specifically in emerging markets. Although these stocks face geopolitical risks and currency fluctuations that contribute to greater volatility, asset owners should consider that such volatility varies dramatically.
Certain risk-averse investors could even benefit from having holdings in lower-risk international equity funds, adding to the diversification of the portfolio.
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