Financial Planning Blog

Posted on: 07/21/09

In Part 1, we looked at what a stable value fund is and how they have performed over the years. Like any investment, however, there are some things to consider before putting your money in a stable value fund. Even with the backing of "insurance wrappers", these funds are not without risk, and there are no absolute guarantees that investors will not see a loss of principal. Obviously, the financial stability of the insurance providers (there are usually multiple ones) is key to the overall safety of the fund. To illustrate this risk, consider that AIG was backing a significant percentage of the wrap contracts in stable value funds when it had to be rescued in the fall of 2008. Unfortunately, stable value funds assets and these insurance contracts are not exactly transparent, making it difficult to assess just how solid the fund is. Although the stability of principal may still be maintained by the fund in the wake of losses and credit issues, it may come at the cost of lower future yield to the investor.

As mentioned in Part 1, there are often restrictions on when or how often an investor can move money out of a stable value fund. This allows the fund to invest for higher yield without the concern of providing ready access to cash, the way a money market fund is required to. These liquidity restrictions generally should not be a major consideration to a long term investor in a 401K or 403B plan. However, these limitations tend to prevent investors from switching between the stable value fund and other fixed income funds that may be currently offering higher yields. 

Like most fixed income investments, there is also the risk that earnings from stable value funds will not keep up with inflation. Also, due to the construction of these investment vehicles, they tend to lag interest rate trends--so they tend to out perform while interest rates are declining, but can lag while interest rates are increasing. Finally, as is critical with all fixed income investments, watch the costs of the fund. If the fund has fees >.5%, think twice before investing. (One local benchmark--the stable value fund in the HP 401K plan has fees estimated at only .07%.)

As reported in the Wall Street Journal earlier this year, the recent market turmoil also brought to light an additional risk element particular to stable value funds. When employers declare bankruptcy and ex-employees move their assets from company retirement plans, the resulting exodus can put substantial strain on stable value funds. As it turns out, most of the insurance contracts protecting assets in stable value funds do not cover employer initiated events such as bankruptcy. The Lehman Brothers' stable value suffered a small mark-down in late 2008. When the retailer Mervyns terminated its 401K plan after going bankrupt, their stable value fund did not lose value, however employees could not get access to funds for months due to withdrawal restrictions.

In spite of these risks, a modest allocation to a good stable value fund still makes sense for many investors. It should prove to be a good diversifier and provide a reasonable return for low risk. However, as we have learned over the last several months, low risk does not mean no risk.

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