Stable value funds are offered in approximately half of all 401(k) plans1 and can be an attractive alternative to money market and bond funds. Given the volatility of the markets over the past several years, you may be tempted to put a chunk of your 401(k) into a stable value fund knowing that while you might not get rich, at least you’re minimizing risk. But there are some things you should know before investing in one.
First, many 401(k) investors don’t really understand what stable value funds are. They’re not publicly traded mutual funds, as you might believe. So what are they? Let’s break it down:
Stable value funds are considered a low-risk, conservative investment and are designed to help preserve capital while providing steady, positive returns. They are pools of money invested in short- to medium-
Stable value funds are designed to help preserve capital while providing, steady, positive returns.
maturity government, corporate and mortgage bonds with a layer of insurance bought from a bank or insurance company. The insurance layer is designed to protect principal (and some accruing interest) should interest rates swing.
Stable value funds are structured in two ways: as a separately managed account, which is a stable value fund managed for one specific 401(k) plan; or as a commingled fund, which pools together assets from many 401(k) plans.
Regardless of how they are structured, stable value funds are composed of a diversified portfolio of fixed income securities that are protected from interest rate movements by contracts from banks and insurance companies. The contract protection against interest rate volatility is provided through the following investment instruments:
The typical stable value fund will diversify contract protection by investing in more than one instrument type and/or with more than one insurance company or bank.
To prevent yield chasing, most stable value funds don’t allow transfers to similar options, such as money market or short-term bond funds. Instead, you have to move your money first into, say, a stock fund, for a period of usually 90 days. This is known as an “equity wash” provision. Be sure to check your employer’s Summary Plan Description for more information or, if your 401(k) account is with Merrill Lynch, go to Benefits OnLine®.
If your employer decides to end its participation in a stable value fund, there may be transfer or liquidation limitations. You should be aware of these prior to investing in the fund.
Moreover, not all stable value funds are created equal. If you work for a small or midsize employer, your fund might rely on a single insurer, offering less risk protection should that insurer become insolvent. Pooled stable value funds, more common at larger companies, typically use multiple insurers.
When deciding if a stable value fund is right for your 401(k) account, keep in mind that investing is not an exact science. There’s no such thing as a “perfect” portfolio. You need to make your investment decisions according to your own specific needs and goals. Start by answering these questions:
How much time do I have?
Your time horizon influences your portfolio strategy. If you’re in your 20s or 30s, retirement is a long way off and you have plenty of time to ride stock market highs and lows. If you’re nearing retirement age, however, preserving the assets you have accumulated is probably top priority.
How much risk am I willing to take?
Generally, the riskier the investment, the higher potential return. Conversely, the less risky the investment, the lower potential return. You’ll want to establish a balance between amount of risk you’re comfortable with and the potential return you’re seeking.
Whenever you invest in mutual funds, you take a risk that the stock market can go up or down. Investing in bonds carries some risk, tied to how interest rates fluctuate. But if you leave your money in conservative investments, you also take a risk that your money will not earn enough to keep pace with inflation.
The sample portfolios featured above range from conservative to aggressive. The money market/stable value category accounts for 20% of the most conservative model, but that percentage decreases as the models get more aggressive. In fact, the money market/stable value category plays no role whatsoever in the moderate to aggressive and aggressive portfolios. That’s because these portfolios are for people seeking to build wealth over time or aggressively build wealth and, therefore, are willing to accept a higher degree of risk by investing mostly in stocks.
Your time horizon and appetite for risk can help you decide if a stable value fund is right for you.
Understanding your tolerance for risk is a very important part of creating an investing strategy. The Interactive Risk Assessment and Investment Guide can help you figure out your unique investment “style.” Follow three easy steps to see your risk profile and a corresponding asset allocation mix. If your 401(k) plan is with Merrill Lynch, go to Benefits OnLine® and select 401(k) Plans > Current Elections > Investment Direction.
1 Source: Stable Value Investment Association, www.stablevalue.org.
The designation “stable value” is not meant to suggest that this investment option will not experience any fluctuations in its net asset value.
Although a money market fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money by investing in this type of fund. Money market funds are neither insured nor guaranteed by the Federal Deposit Insurance Corporation or any other government agency.
Investing involves risk, including the possible loss of principal. Investments in foreign securities or sector funds, including technology or real estate stocks, are subject to substantial volatility due to adverse political, economic or other developments and may carry additional risk resulting from lack of industry diversification. Funds that invest in small- or mid-capitalization companies experience a greater degree of market volatility than those of large-capitalization stocks and are riskier investments. Bond funds have the same interest rate, inflation, and credit risks associated with the underlying bonds owned by the fund. Generally, the value of bond funds rises when prevailing interest rates fall and falls when interest rates rise. Investing in lower-grade debt securities (“junk” bonds) may be subject to greater market fluctuations and risk of loss of income and principal than securities in higher rated categories. There are ongoing fees and expenses associated with investing. Bear in mind that higher return potential is accompanied by higher risk.
Investors should consider the investment objectives, risks, charges and expenses of investment options carefully before investing. This, and additional information about the investment options, can be found in the prospectuses and, if available, the summary prospectuses, which can be obtained on Benefits OnLine at www.benefits.ml.com or by calling Merrill Lynch at (800) 228-4015. Investors should read the prospectuses and, if available, the summary prospectuses, carefully before investing.
The sample portfolios are not intended to represent investment advice. This material does not constitute a recommendation as to the suitability of any investment for any person or persons having circumstances similar to those portrayed. Each investor’s portfolio must be constructed based on the individual’s financial resources, investment goals, risk tolerance, investing timeframe and other relevant factors. The categorization of sample portfolios as “Conservative,” “Conservative to Moderate,” “Moderate,” “Moderate to Aggressive,” and “Aggressive” is relative. Ibbotson has changed the allocations for each model in the past and may change the allocations in the future. Merrill Lynch does not recommend any specific asset allocation model.
The sample portfolio models above are used with permission, ©2012 Ibbotson Associates, Inc. All rights reserved.