Financial Planning Blog

If you participate in an employer sponsored retirement plan such as a 401K or 403B plan, one of your investment choices may be something called a stable value fund. (Other possible names are interest income, principal preservation, or guaranteed interest funds.) In periods of healthy stock market returns you may have ignored these funds--after all, most of us are looking for high returns and values that grow, not stay stable. However, with the significant declines of the last year and a half, many investors have taken a fresh look at the fixed income side of their retirement plan investment options in an effort to better manage the risk of their portfolios. So, what is a stable value fund, and should it be part of your retirement plan portfolio?

Stable value funds are a hybrid fixed income investment that are designed to offer stability of principal similar to a money market fund, but have the higher expected returns of short or intermediate term bond funds. This combination of safety and expected return, along with a lack of correlation with stock prices (i.e. they are not expected to go down when stocks go down), make them a prime candidate for inclusion in a well-diversified portfolio. They, along with other fixed income investments like bond funds, provide the necessary ballast to manage the risk in your retirement portfolio. Stable value funds are available options in more than half of the 401K plans, and according to the Stable Value Investment Association (yes, they have their own association), and around 12% of the assets in those 401K plans are allocated to these funds. (This percentage presumably has risen as equity fund values have plummeted.)

Although stable value funds have attributes similar to both money market and bond funds, they are an asset class unto themselves. Initially, these funds were structured as guaranteed investment contracts (GICs), which are contracts issued by insurance companies to the retirement plan guaranteeing investors a fixed rate of return. While this may still be the case, most stable value funds are now structured as synthetic GICs. These synthetic GICs are diversified portfolios of primarily high quality bonds of short to intermediate duration combined with various "insurance wrappers". These insurance wrappers are contracts where a highly rated insurer guarantees to make up the difference if the portfolio value drops below a given level, providing the stability of net asset value (NAV) similar to money market funds. Also contributing to the stability of NAV are book value accounting (similar to money market funds), and some restrictions on exchanges into and out of the fund.

Have stable value funds performed as designed? According to data from Vanguard, the Hueler Analytics Stable Value Pooled Fund Index (an index representing about 75% of stable value fund assets) averaged an annual return of 6.9% from 1984 through 2008. Over the same time period money market funds averaged only 4.71%. Short term bonds funds and intermediate term bond funds returned only 5.1% and 6.22%, respectively. Surprisingly, while outperforming all three of those fixed income asset classes, the stable value funds experienced considerably less volatility (i.e. risk) than even the money market funds. While this is no guarantee of future performance, it does make them worthy of consideration as part of your fixed income allocation.

Next, we will look at some of the risks of stable value funds.