Stable value: 401(k) ‘anchor’

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If you’re one of the many who has your 401(k) retirement fund invested in a stable value fund, a white paper produced by Prudential Financial shows that you are probably doing some smart retirement planning.

The paper says that while investors aren’t getting rich fast, stable value funds consistently outperformed other investments that are considered safer. From 1989 to 2009, stable value funds produced an average annual return of 6.1 percent. Meanwhile, their closest competitors, intermediate-term bond funds, averaged 5.6 percent, and money market funds offered 3.9 percent.

In the bad years, stable value funds protected investors from the worst. In 2008, when the Nasdaq dropped nearly 34 percent and the S&P 500 fell 38 percent, stable value funds produced an average annual return of 4.17 percent. Throughout the financial crisis, if you were fully invested in stable value, you almost certainly didn’t lose a penny.

Post-2008 financial reforms have resulted in tighter controls on stable value funds that have driven up fees and lowered returns somewhat. But these changes are also strengthening these investments. As outlined in the paper by Prudential, these reforms include:

  • Higher fees for stable value “wrap contracts,” which guarantee stable value principal and earnings.
  • Tighter rules on transfers between stable value investments and competing funds are reducing the likelihood that short-term interest-rate arbitrage will harm long-term investors.
  • More conservative investment guidelines are adding further protections to the asset class, making it more resistant to future market dislocations.
  • Market-value-to-book-value ratios for stable value have improved, positioning this asset class for future changes in interest rates.

Despite the higher fees and lower returns, stable value is an increasingly popular 401(k) investment. Aon Hewitt 401(k) Index, which tracks 401(k) plans, says $7.1 billion was contributed to the stable value funds in 401(k) plans from 2008 through the first 11 months of 2012. In all, there is about $645.5 billion invested in stable value funds in 401(k)s. This represents about 14 percent of all 401(k) savings in these plans.

Money market funds and investment grade intermediate bond funds each have their strengths. Money market funds are redeemable at any time, for any amount and for any reason. But their returns have been lower than that of stable value. Bond funds are comparable in their rate of return, but they can be much more volatile than stable value.

Stable value probably shouldn’t be your own investment — especially if you have time to invest more aggressively and recover from any downturns. But Prudential’s white paper analysis concludes that for many people saving for retirement, stable value funds are “the anchor that allows them to invest more confidently in a broadly diversified portfolio.”