Should I Invest In My 401(k)’s Stable Value Fund?

While investigating the bond options in my wife’s 401(k), I noticed that the only “safe” option in her account was a Stable Value fund. I have noticed this label before, but never really paid them much notice. What is a stable value fund?

The pitch: “Cash with better interest”. You get the safety and stability of principal found in a money market fund, but with the higher returns of an intermediate bond fund. Here is a graph from 1990-2006 via the Stable Value Investment Association website (yellow is money market, blue is stable value, and red is bond fund):

How? In essence, stable value funds invest in intermediate-term bonds and similar investments, but the usual day-to-day fluctuations are smoothed out by the guarantee of an insurance company. For example, the insurance company guarantees that a certain amount of interest will be paid. If the actual return from investments fall short, the insurance company makes up the difference. If the actual investments outperform, then the insurance company keeps the difference.

This insurance guarantee also keeps the per-share price (NAV) at $1, much like a money market fund, even though the assets being held are riskier. Because they are limited to qualified retirement plans like a 401(k) or 403(b), they are allowed to use “book value accounting” instead of the more strict daily “market value accounting” required of most retail mutual funds.

What are the risks? In most cases, even if investments perform poorly, the insurance company will eat the loss rather than face the bad publicity. This is similar to money market funds. However, the danger is when things go so bad that the insurance company goes bankrupt. An example is the Trust Advisors Stable Value Plus fund which failed, as outlined by this NY Times article. Although technically the investors eventually recovered all their principal, it took over a year for everything to settle. There have been other isolated instances where investors have lost a portion of their principal.

To invest or not? Stable value funds are pretty popular, and found in 2/3rds of all 401(k) plans. Who wouldn’t want a fund with hardly any volatility that pays high interest? The fund in my wife’s 401(k) is “guaranteed” to earn 4.55% for all of 2008. Be careful though, because they are not all made the same. According to this study by JP Morgan Chase, returns from good/bad stable value funds can differ by up to 2% per year.

As for safety, I would treat it like a money market fund in that you should only buy if you trust the insurer and learn about the actual holdings. Otherwise, buy a bond fund somewhere else if you smell something fishy. Unfortunately, if you really want a “safe” holding place inside your 401(k), many times you don’t have much choice. Finally, I would also point out that in the end they are still bonds, and are subject to the risk of having their modest returns eaten up by inflation. If you are a young investor, stocks still provide the best long-term growth prospects.

Comments

  1. You answered your own questions in the end (No).

    From your blog:
    “If you are a young investor, stocks still provide the best long-term growth prospects.”

  2. Excellent post, Jonathan, thank you.

    It seems that the stable value funds are making money by selling protection against the short-term volatility of the underlying bonds. The investor is sacrificing some of the returns that would be provided by investing in a bond fund directly for the comfort of knowing the NAV will never go down.

    For a retiree, this might be more attractive than a direct investment in bonds. But for someone accumulating with a 30+ year horizon, I can’t think stable value funds would be a reasonable choice.

  3. No… as Robert said… you answered your own question.

    In the long run your return will be much greater on the stocks you are buying now than with the stable fund.

  4. MBirchmeier says:

    Even for the bond portion of of your portfolio, this seems like a bad idea.

    This just seems like a fee to smooth out volatility. While volatility is uncertain, the insurance fee is a guaranteed drag on returns.

    If you were drawing from your bond funds rather than building them up I think the cost might be worth the stability, but while earning this seems like paying for peace of mind you’ll never notice.

    -MBirchmeier

  5. simplesimon says:

    A lot of people don’t have a choice when it comes to choosing fixed income holdings because their asset allocations calls for a certain percentage of bonds. I think stable value funds are fine (but of course always check the prospectus to see what its holding).

    @MBirchmeier
    If someone was drawing from their bond funds, I’m assuming that they’re retired and in that case, the 401k should be rolled over to a mutual fund company IMO. Then they wouldn’t have to deal with it and would have a lot better choices of funds.

  6. I was doing the exact thing you were doing Jonathan, except I was rearranging my sister’s 401K funds for her. She’s in her late 20s and yet has more than 50% of her funds in a Stable Value Fund! D’oh! I immediately moved her out of it into a target retirement fund earlier this year. With the recent market performance, she wasn’t too happy with her statement but I told her this is for her good in the long run.

  7. For every person saying “this is good for you in the long run,” there is another person who hasn’t lost 50% or more this year in their 401k. I’m under 30, but have slowly moved more and more of my money into my stable value fund this year (SSgA).

    A lot of my coworkers have lost 20,30,40% of their 401k money where I’ve only lost less than 10% because 60% of my money is in a stable value fund. When the market starts to act like it’s recovering, I’ll reshuffle, but doesn’t it seem stupid to lose money when you don’t have to? I may not catch the absolute bottom when it starts to recover (and maybe it already has started to do that), but I’m OK with that, knowing I haven’t lost a gazillion dollars waiting for that moment.

    One coworker put his entire 401k into the stable value fund early this year and hasn’t put it back in. He has actually made money this year! How many people can say that?

  8. Stable value right now… 90% of the time this is the wrong answer, but now it is not.

    The risk outweighs the reward. Potential declines outweigh potential rewards… I switched entirely over the stable in Feb 08. Stocks can and have declined 90% in a few years, the have never done that on the upside. Patience people, wait for a true bottom. There a serious underlying problems that need to be fixed and this is just the beginning (and we’re already address the symptoms not the causes).

    Now time for me to be slammed with about 2 dozen “stocks are cheap!” posts…

  9. JP @ TickerWatcher.com says:

    Interesting article – thanks for the read =)

  10. Donny Gamble says:

    The more diversity that you have in your portfolio the better. Even though it might be a little riskier or not make you that much money, being conservative with your investments aren’t always a bad thing.

  11. Sounds like bonds would be better. If you are investing every month, since it as a 401(k), you are effectively dollar cost averaging and you will in fact benefit from the fluctuation when you buy cheaper shares. If it is smoothed out for you, you will lose that benefit.

    I think it was Stocks for the Long Run that noted that the reinvested dividends during the 1929 crash cause investment performance to ultimately perform better over the long run than if that significant dip had not occurred. It’s the same kind of principle at work there. If you’re going to end up at the same place anyway, fluctuation along the way boosts your return.

  12. So based on a reasonable inflation number for the year. This form of investing didn’t even defend its own buying power for the year.

    That’s not a great record.

  13. If I were looking at investments and deciding where I’d put my money, it’s not the choice I’d make. That being said, my parents are in something similar through TIAA-CREF, which I mocked at the time. I’m now eating my words, wish I had something similar.

    @Johnny, don’t know if stocks are cheap, but they are definitely cheaper than they were!

  14. Johnny/Dave, that was very smart of you.

    Eric, blow your own money, not your sister’s retirement. Since she’s only in her 20′s, having her money out of stocks for a year won’t hurt her. The worst case scenario is that she’ll have 4.55% more on 50% of her holdings that she can then diversify in a year or so.

  15. What Johnny and Dave are describing is market timing. Market timing, for almost all amateurs and even most of the pros, is generally a Bad Thing. The odds of you moving too early or waiting too late generally result in, at the least, making less money than if you’d just left it alone in the first place. Plus, many 401(k) plans put fees in place to keep you from doing this, which makes it an especially bad choice to play around with.

    As Don said, in the long run, dividend reinvestment with equities has always won. The question is whether you’re in for the long run. I’m under 30 and I’m snatching up equities as fast as I can.

    Jonathan, unless I’m doing my math wrong, your chart shows an average year-year return of over 7.5%. That would almost beat historical stock returns, even in good markets, with theoretically zero risk. Sure it’s right? I look at the stable value fund in my 401(k) and it’s yielding 3.75%, exactly half that.

  16. Thanks for the post. I never thought of a Stable Value Fund, I must look into this. But I heard a few times in this post that one should look at what the fund is holding. Could someone please tell me what I should be looking for? What are the red flags I should be looking for? What are the good holdings in the fund that I want to see? Thank you. Be well.

  17. Mike, I most certainly do not pretend to be able to time the markets…

    If one looks even casually into trading they’d see that the buy and hold returns would have been tremendously improved by following simple, but major, trading indicators.

    The outlook is terrible. In technical analysis this has happened once. Maybe. Right before the great depression. Where things seesawed up and down on their 3 year, 90% decline with false rallies the whole way down. This is a once in a lifetime event (hopefully)…

    Do I think I’ll get in at the bottom? Absolutely not.

    Will I miss out on the biggest part of a bull market? Quite likely.

    Could the market go up 25% this year? Possibly.

    Could the market decline an additional 40% next year? I find it more likely than a 25% rise.

    I’ve been trading actively trading for years. I spend probably 20 hours a week on it and have for years. I understand most don’t want do that… But the first rule is risk management, capital protection. I cannot time much, but I can recognize obvious trends.

    Buy and hold works for the huge majority of entries. But right now, I find it far to risky. I wouldn’t have done it 6 months ago, I wouldn’t do it now.

    My advice, if you do enter now, to is pre-define your risk. Set a “crazy” point where you will pull the plug… So you don’t do the whole deer in the headlights thing.

  18. During the peak of the market I had moved most of my money into the Fidelity Capital and Income Fund. A bond fund with some equities but higher paying dividend each month. If I had known what was going to happen to the market I would have definitely invested in the Stable Value fund through the 401K. I think it is good to use if the market is high and you anticipate a fall. At this point I will be shifting more and more into stocks and investing future contributions to stock just because of the huge gain that will be incurred over the long term. I do really like the capital and income bond fund because it does pay out great dividends each month, just with a little more risk in these turbulent times because of its slight weight in equities.

  19. I went 100% into my 401′s Stable Value fund the beginning of September. No regrets! When the available mutual fund choices get above their 20-day moving averages I’ll start scaling back in.

  20. Taking some risk is healthy, as long as you match your risk appetite to your risk tolerance. It is important to estimate your risk tolerance. One could use this financial analyzer or some other tool. Accepting lover return for the promise of “no loss” for your entire portfolio simply means that you accept the loss from missed opportunities.

  21. Moody,

    You get “lover return” from your investments?

    No fair! In a good year, Vanguard only gives me boring old dividends and capital gains!
    :P

  22. Monica Sandler says:

    I agree with Moody, whether or not ‘stable value’ is for you is determined by your risk appetite. If you can bear lots of risk and invest in something ‘stable’, it’s like you are missing opportunities.

    Thanks for the link, Moody. That Ameri-Financial calculator / analyzer is fantastic, i finally got to see where all my finances stand. Has it been working for you?

  23. Here’s the magic question:

    Do you have 6 months of salary in a liquid savings account?
    If not, you have no business investing in a 401k.

    It’s amazing how blindly people invest a percentage of their earnings every two weeks without having anything to fall back on in case of an emergency. So the 401k becomes their savings account with a 10% withdrawal penalty attached to it. Nice return on your money there.

    After tax investing is not that stupid and it worked just fine for decades before 401k’s arrived.
    401k’s are not magic bullets to save you from the IRS. They are especially worthless when you consider the fact that they replaced your pension.

  24. I have my 401K money in the JP Morgan Chase Stable Value Fund. I was receiving about 4.5% until 12/1 and the return dropped to 2.8%. I called JPM and they would not provide any information concerning the large drop. The only way I could rationalize the drop is if all the paper they held came due on 11/30 but would have thought they would have had a laddered approach. The other theory is they had ‘wrap’ exposure or underlying security exposure that they are attempting to smooth out hence lowering the rates.

    Does anyone have factual information on what event occured on 12/1/08 in this particuliar fund? I am upset that JPM could not provide more detailed information on the factors impacting the fund.

  25. Donald Hoppenjans says:

    I’m invested in DuPont’s Stable Value Fund and its return also dropped recently by a significant amount. It is heavily invested in fannie mae and freddie mac mortgage securities. To what extent are these government mortgages insured?

  26. Lansing Bicycle Joe says:

    State Street Global Advisers stable value is down to 2.8 – 2.9%.

  27. SteveTheHawk says:

    Over the past year I have moved a lot of my 401K to Stable Value (SSGa). It’s about 70% at this point (used to be 10%). I fully anticipated a drop in interest income. After all, nobody is paying decent interest these days without also providing a lot of risk. Stable Value is about low risk and I’m quite happy about that. Over the last year it has provided returns about 50% above any of the stock funds in my 401K. Looked at from that angle, it’s a no-brainer. Until the economy proves that it won’t just collapse in on itself, I’m not interested in stocks much. Buy and hold is quite clearly a dumb idea.

  28. Joe Sixpack says:

    I have 3 different stable value funds. 2 are from big companies (they “manage” the funds, whatever that means.

    The 3rd is with a huge bank which I don’t want to name here because I don’t want it to get bad press. I am sort of forced to own the stable val in this bank because my 401K has no better place for my money ! I’ve noticed that they are being sneaky about losses they apparently are suffering. The NAV keeps creeping up slightly, at a 4 % rate, to give the appearance to outsiders that all is well, but every now and then approximately once every 2 months, I get a transaction (by going online to the bank’s website and looking up my account) stating “earnings gain/loss -x.xx” the last one was “earnings gain/loss -$10.10″ The “earnings gain/loss” is always negative, never positive. Seems like they are taking my prinicipal out to cover losses. Oh yeah, my number of “units” gets decreased slightly with each of these “earning gain/loss” things.

    So they are selling off a few of my “units” every so often to prop up the NAV. The NAV is not $1.00 by the way. It’s some number that keeps creeping up.

    Even with the whittling away of my principal, I’m getting about a 3 % annual return, which is OK with me, but I do worry about a big “unanticipated” plunge in the future. I do not trust ANY place with my money these days. Too bad there just aren’t any good options in my 401K.

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