Protect Nest Eggs With Stable Value Funds
In recent years, stable value funds have served as workhorse investments, accounting for 12% to 15% of assets in 401(k) and other defined contribution retirement plans. The funds have $540 billion in assets, according to the Stable Value Investment Association.
The value of the stable funds became clear as the financial crisis savaged 401(k) plans. During 2008, stocks plummeted, and many bond funds dropped sharply. But throughout the turmoil, millions of savers were protected by holding stable value funds. Nearly all the funds stayed afloat, returning more than 4% for the year.
Some investors think of stable value funds as bank accounts. The funds protect principal and pay interest. But the stable value accounts are not guaranteed by the Federal Deposit Insurance Corp. Instead the returns of the funds are protected by insurance contracts known as wraps that are offered by banks and insurance companies.
In some key respects stable value funds resemble intermediate-term bond mutual funds. Both kinds of funds invest in portfolios of bonds. When interest rates rise, the value of the bonds tends to fall. If that happens, a shareholder in a typical bond mutual fund could lose principal. In contrast, a saver who makes a withdrawal from a stable value fund would not suffer because the insurance contract protects against principal losses.
In the event of bankruptcy or other problems, stable value funds can lose the insurance protection. But when the insurance lapses, savers do not necessarily suffer big losses. After Lehman Brothers went bankrupt in 2008, insurance coverage terminated for the company's 401(k) plan. Lehman employees with assets in the stable value fund lost about 1% of their principal. That was an annoying outcome -- but not as devastating as the losses that many investors suffered in the stock market.
For protection, stable value portfolio managers tread cautiously, putting nearly all their assets in bonds that carry the highest credit ratings of AAA and AA. In contrast, many intermediate mutual funds hold bonds of varying credit qualities, including issues that are rated BBB, the lowest investment-grade category.
Stable value funds also limit risk by holding a mix of maturities, including intermediate-term bonds as well as short-term bonds. When interest rates rise, bonds tend to fall. But the stable value portfolios suffer only limited swings because short-term bonds tend to be resilient. Intermediate funds have longer average maturities, which makes the portfolios riskier.