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Playing it safe is tricky for retirement investors. Buy a money market mutual fund and you won’t lose any money. But you also won’t earn much, either—and you may even forfeit purchasing power over time. Since the end of the Great Recession, money market fund yields have been stuck well below the rate of inflation. You could try bonds, of course. Bonds funds offer higher yields, yes, but then you get more risk, too.
What’s a risk-averse retirement investor to do? Perhaps turn to stable value funds, a potential goldilocks solution that may already be available in your workplace retirement plan.
What Is a Stable Value Fund?
A stable value fund is a low-risk investment (like a money market fund) that delivers higher yields (like a bond fund). It’s able to do this because it holds a short-term bond fund as well as an added insurance feature that kicks in to protect investors from losing any of their principal.
While high-quality bond funds are low-risk investments that are much less volatile than stocks, there’s still no guarantee that the value of a bond fund won’t decline when interest rates rise.
The long-term average quarterly return on stable value funds historically has been more than a half a percentage point better than the return on money market funds, and the average stable value fund’s return was on par with the return of intermediate-term government bond funds.
How Do Stable Value Funds Work?
To appreciate how stable value funds operate, it’s useful to first review the mechanics of how bond funds perform as a bond fund is the core component of a stable value fund.
There are two moving parts to bond fund performance. The yield of the bonds held in a fund’s portfolio and the price of those bonds.
When interest rates rise, the yield of the bonds owned by a fund rise as well. But when bond yields gain, their prices decline. It works the other way around, too: When bond yields fall, bond prices rise.
As a bond fund investor, what you earn is known as the fund’s total return. It’s a combination of the yield and changes in bond prices. When interest rates rise—and especially when bond yields are starting from very low levels—a bond fund’s total return can occasionally turn negative. That happens if the decline in bond prices is more than the yield the fund is earning.
Now back to our main subject: The stable part of stable value funds refers to how the funds eliminate the chance of ever seeing a negative return. The insurance features they add to the underlying portfolio of bonds effectively removes the risk that if interest rates rise your stable value fund investment will lose money.
What Does a Stable Value Fund Own?
There are two components to a stable value fund: bonds and insurance contracts.
Stable value funds typically invest in short-term US government bonds and high-quality corporate bonds. The duration for stable value funds is typically around three years or so. The longer a fund’s duration, the more sensitive it is to interest rate moves. In comparison, if your 401(k) plan offers a total market bond fund—most do—its duration is likely around six years, leaving it more susceptible to interest rate changes.
In addition to bonds, a stable value fund also invests in insurance contracts that are issued by insurance companies or banks. Like all insurance, the purpose is to provide protection. For stable value funds the insurance is designed to make sure that no matter what is going on with interest rates, the value of the fund will not fall. Like a money market mutual fund, stable value funds aim to always maintain a net asset value (NAV) of $1.00 per share.
It’s this so-called insurance wrapper that enables stable value funds to deliver the higher yields of short-term bonds with the same low-risk of a money market mutual fund. Many stable value funds spread their insurance contracts among multiple insurers or banks to add an important layer of risk diversification. That way if one insurer defaults or is unable to meet its obligations, the fund overall won’t lose much, if any, money.
How to Invest in a Stable Value Fund
Stable value funds are only available to participants in 401(k) plans and other defined contribution retirement plans. That’s important to be aware of because if you roll over a 401(k) to an individual retirement account (IRA) you won’t find a stable value fund offered by the brokerage where you have your IRA.
(Note: If you’re saving for a kid or grandkid’s college, stable value funds are allowed in 529 college savings plans, though.)
That said, just because you have a 401(k) doesn’t mean you’ll be able to invest in a stable value fund. According to the Plan Sponsor Council of America, more than 30% of plans lack stable value fund offerings, though this number shrinks for larger plans with at 1,000 participants.
When looking to see if your 401(k) offers stable value funds, keep in mind that they come in a variety of names. Look for fund names that riff on terms such as principal preservation, capital accumulation or guaranteed income.
When you find a fund, be sure to check the annual expense ratio. Given the added cost of the insurance component in a stable value fund, the expense ratio may be higher than the cost of a comparable core bond fund. That’s not necessarily a deal breaker. But if there’s a wide gap you need to decide if it’s worth the extra cost for the security a stable value fund provides.
How Stable Value Funds Fit into Your Retirement Portfolio
Matthew Schwartz, a certified financial planner (CFP) at Great Waters Financial in Richfield, Minn., suggests that stable value funds can be used as a “complement” to bond funds in your portfolio. While core bond funds can lose principal during periods of rising interest rates, those dips are typically small and infrequent. Moreover, if you switched your bond holdings exclusively to stable value funds, you’d miss out on gains when bonds rally.
“We want to be able to capture some of the principal appreciation that a bond fund can have when interest rates are decreasing,” says Schwartz. “A stable value fund doesn’t give you that upside when rates are falling. That stable is stable.”
Ultimately, though, how much of your bond allocation you might want to move into stable value funds is a matter of personal choice, based on your risk tolerance. If you really hate the idea of any price volatility, you might want to invest more of the fixed income portion of your portfolio in a stable value fund than in a core bond fund.
Stable Value Funds and Retirement
For retirees who want to set aside a few years of living costs in cash, the stable value fund in a 401(k) might provide a higher yield than parking money in a money market mutual fund.
That can be an argument for not rolling over a 401(k) into an IRA, or if it is allowed, doing a partial rollover, where you leave some money behind in the 401(k), so you can continue to earn the money-market-beating yields of a stable value fund.
Should You Invest in Stable Value Funds?
Stable value funds aren’t just for retirees, Schwartz notes. It’s perfectly legit for younger retirement savers who prefer to reduce the volatility of the fixed-income portion of their allocation strategy to use stable value funds, he says.
But with one caveat: The longer your investment horizon, the more your asset allocation strategy should focus on stocks, not fixed income of any time. The certainty stable value funds provide could block you out of decades of exponential equity gains.
