Could a rise in interest rates create a problem for short term TDFs? With many TDFs moving to bonds for safety as their target dates approach, they’re vulnerable to losses if interest rates rise and bonds slump — which many are predicting. Risk can be determined by calculating the duration of the bond — for example, the value of a bond portfolio with a five-year duration could drop 5% with just a 1% rise in interest rates.
These losses could be offset by interest payments and inflation-protected bonds, as well as improving stocks resulting from a strengthening economy — which usually spurs interest rate spikes. Nonetheless, most of the bigger TDFs funds have significant bond exposure. If interest rates were to double, losses could be in the 8-10% range.
