With bond markets in turmoil, what is a 401(k) investor to do? Probably not much.
Retirement investors have enjoyed the best of both worlds these past two years: a bull market in both equities and bonds. But the bond market has been weathering volatility and sharp declines since late April, with prices falling and yields rising.
Bond experts are not certain that the bond party is over yet, but the recent volatility raises a question: should 401(k) investors take steps to protect themselves in the event of a sharp spike in interest rates and accompanying fall in bond valuations?
Experts do not think so. Unlike the world of active bond traders, retirement investing is a long-term game. Although the price of bonds moves in the opposite direction to their yield and hence fluctuates, principal always is returned if the bond is held to maturity.
And most 401(k) investors are in bond mutual funds for the fixed income portion of their portfolios, which are highly diversified and usually invested in intermediate (five-year) high-quality government and corporate bonds.
"If investors stay course and their holding period is longer than the fund's duration, rising rates should be not much to fear," says Fran Kinniry, a principal in Vanguard's Investment Strategy Group.
Kinniry adds that the enduring low-rate environment has led retirement investors to change their view of the role bonds play in their portfolios. For a very long time, they saw bonds as an asset class delivering yield. But with such a low rate environment, the real role of bonds is to truncate or reduce equity risk, especially for older investors and retirees, who still may have 30 or 40 percent of their assets in equities.
As a result, retirement investors have taken the recent bond market volatility in stride. "We're not seeing any real dramatic cash flow out of fixed income," Kinniry says.
Automation is another key factor reducing the drama of the bond market's volatility.
About half of all 401(k) plans now offer one-on-one financial counseling, online advice or managed account services, according to Aon Hewitt, and roughly 10 percent of workers at those firms are taking advantage of the services. A bigger trend is the investor shift to target date fund (TDF) series, which follow predetermined asset reallocations based on a specified expected retirement date, with a shift toward income as retirement gets closer.
TDFs weight younger investors' portfolios heavily toward equities, and that is reflected in overall market data. Just 5 percent of all 401(k) assets held by participants in their 20s were in bond funds in 2013, according to the most recent data from the Investment Company Institute (ICI). By contrast, 11.6 percent of assets held by account-holders in their 60s were in bond funds.
But TDFs, and other managed account services, also aim to improve the behavioral aspects of retirement investing, removing the inclination to react to sharp price swings or to time the market. ICI reports that 71 percent of 401(k) plans offered TDFs in 2013, and that 41 percent of account-holders had at least some assets in them.
Keeping funds balanced leads to positive results. Vanguard historical analysis shows that a portfolio of 55 percent equities and 45 percent bonds has had an average annual return of 8.58 percent since 1926, compared with 10.24 percent for stocks. The worst annual return was a negative 24.6 percent, compared with negative 43.1 percent for stocks only. 
A small number of TDF series are using nontraditional bond funds, which take short bond positions to protect against rising interest rates. This is a small but growing trend. Eight out of 50 TDF series tracked by Morningstar are using nontraditional bond funds, and none of the big three players, Vanguard, Fidelity and T. Rowe Price, employ the strategy. "They actually benefit if rates rise," says Jeff Holt, a fund analyst at Morningstar. "But if rates continue to fall or don't rise, you run risk."
If you are near retirement and the bond market is keeping you up at night, you could diversify some of the nonequity portion of your portfolio, suggests Lucas Turton, chief investment officer at Windham Capital Management. If you are 30 percent in bonds, move half of that to cash (a money market fund) or a stable value fund, he says.
"I'm suggesting a move toward safety and higher security, but it's difficult advice to take because it guarantees a negative real return. The alternative is taking interest rate risks and perhaps seeing bond and stock prices fall simultaneously," he adds.
Longer term, a return to a higher-rate environment would be very positive for retirees, who depend on bonds and even certificates of deposit for income. They have been suffering through an extended yield drought ever since the Great Recession.
Vanguard's Kinniry thinks rates ranging from 2.5 percent to 4 percent could be in the offing. "But we're not seeing any signal calling for runaway bond yields," he says.
(The writer is a Reuters columnist. The opinions expressed are his own.)