Low interest rates have been very painful for retirees and other savers, as rates paid on bonds and other investments have fallen.

What hasn't been discussed nearly as much is that the situation for that group of investors could get worse. Not that rates will fall much further, as they are well below 2 percent already for securities like 10-year U.S. Treasury notes. The threat is that interest rates will rise.

That's because bond pricing acts like a seesaw, and as interest rates rise, the value of a bond falls.

The Minneapolis investment management firm of Sit Investment Associates recently published its third-quarter investment outlook and strategy report, and in an exhibit in the back it laid out on one page its expected range of future fixed-income returns.

It grouped its forecast by maturity, from two years to long-term, and then split it again, by pessimistic, most likely and optimistic views. In the column under returns over the next three years, all the annualized return numbers were negative.

In the category of 10-year bonds, Sit's pessimistic view was an annual return over three years of -8.9 percent. The optimistic view was -3.7 percent.

That's what's worse than low yields.

Roger Sit, the firm's CEO and global chief investment officer, said he is not sure how well average investors understand the relationship between rising interest rates and falling bond prices, and he is sympathetic with the plight of savers and retirees, describing them as "kind of stuck, unfortunately."

In terms of asset allocation, his suggestion is that those folks with at least a three-year to five-year time horizon consider layering in a diversified portfolio of stock investments on top of fixed-income holdings. He said the word diversified at least four times in a relatively brief conversation.

Janelle Nelson, a portfolio analyst with RBC Wealth Management-U.S. in Minneapolis, said she's been hearing a strong sense of fear from clients. "The question is not the return on principal, it's the return of principal."

Her own work includes creating a portfolio of dividend-paying stock investments, trying to come up with income-oriented investment ideas for clients unwilling to stay in lower-yielding bonds.

She said she has noted cases in which the dividend yield on a stock of a solid company exceeds the interest rate on the same company's five-year bonds. Yet the bonds sell.

Nelson said "our collective experience with bonds has been good," and that's because it has been a pretty good run for bonds.

The total return for the Barclays U.S. aggregate bond index was nearly 8 percent last year. For the last 30 years, going back to the high-interest-rate environment of the early 1980s, the average annual return for this index was in excess of 9 percent, with some very good years in there.

That long rally in bonds was due to a number of factors, with the most recent push coming from the Federal Reserve's policy of monetary easing. The last round was announced six weeks ago, and in layman's terms it mostly means the printing of money to stimulate an economy that's struggling to grow.

In conversations last week with managers of large endowment and other big pools, there was both an acknowledgement that there could be some pain for bond investors fairly soon but also a belief that there wasn't much reason to think institutional investors were likely to fundamentally move away from bonds.

Why no shift?

Well, it would be market-timing for one thing, and market-timing -- picking when to sell and get out of a market and when to get in -- is something even the pros don't appear to fully embrace. The conventional wisdom, of course, is that average investors are abysmal at market timing.

Another point a chief investment officer of a good-sized endowment made is that picking an asset allocation model and sticking with it is a form of buy-low, sell-high discipline.

If someone chose to put 15 percent in bonds, for example, and a big move in bond prices takes the percentage up to, say, 17 percent, then selling bonds to get it back down to the target is effectively selling high. And presumably the proceeds from bond sales would go into assets that have not performed as well, perhaps stocks. That's buying low.

And finally, even with interest rates so low, there is still a bullish case for bonds. It's not a particularly rosy view, because it's based on the assumption of very little or no economic growth or even the possibility of deflation, which means falling prices for things consumers and businesses buy.

Holding bonds in a deflationary environment can actually work pretty well, because buying a bond for $10,000 that yields next to nothing at the time of purchase can still be a good deal -- if when the bond matures that same $10,000 can buy more goods and services than it did before.

Howard Bicker, executive director of the Minnesota State Board of Investment, came the closest of the big fund managers to talking about an allocation change. For its biggest pool, the state board is allocated 18 percent to fixed-income and 2 percent to cash, with the rest allocated to stocks or alternative investments.

"We are slightly underweighted in fixed income" relative to other big public funds, he said, adding that the fund is required to keep a certain amount of bonds.

"But bonds over the next five years," he said, "are probably not going to give you much of a return."

lee.schafer@startribune.com 612-673-4302