If you’re a participant in a 401(k) plan there’s a better than average chance that you have the option of investing in a stable value fund. There’s an equally likely chance that you don’t know what a stable value fund is.
In education meetings they are typically described as something “close to a money market fund.” Let’s take that statement at face value and look at some of the specifics:
- Money market funds are invested in short term, high quality, highly liquid investments such as certificates of deposit and t-bills (and have an average maturity that is typically 90 days or less). Stable value funds are invested in a range of intermediate bonds as well as the general accounts of insurance companies (with average maturities of up to five years).
The difference? By purchasing short term investments with the highest ratings money market funds take significantly less risk. Generally, less risk means less return over the long haul. On the other hand, stable value funds invest primarily in the intermediate term bond market – taking more risk and, hopefully, providing higher returns.
- Money market funds, as short term investments, are immediately impacted by changes in interest rates (you may recall that not too long ago it was very possible to receive a rate of 4 – 5% on a money market fund; that same fund as of September, 2008 probably pays more in the range of 2%). Stable value funds purchase insurance “wrap” contracts and credit today’s rate based on a blend of past and present interest rates.
The difference? When interest rates plummet, as they have recently, money market funds pay rates that reflect 100% of the decline. The opposite is also true as money market funds paid double digit returns when rates spiked in 1980. Stable value funds, on the other hand, smooth out the peaks and valleys of interest rate changes through the use of the insurance wrappers and crediting techniques.
- Money market funds are typically offered to the general public as well as retirement plans. Money market funds are mutual funds and, as registered products, can be purchased in any type of account. Stable value funds are not mutual funds. Stable value funds are typically collective investment trust products offered only within qualified retirement plans (like a 401(k)).
The difference? Information on money market funds is publicly available while investors in a stable value fund can only receive information on the fund directly from the company that is offering it.
- Money market funds and stable value funds may both invest in bonds offered by the U.S. government, but neither type of investment offers a guarantee of principal (there are a few exceptions to this rule on the money market side of the equation).
The difference? In most cases there is no difference. Neither type of investment is guaranteed. While neither type of fund is designed to lose principal, it has happened on rare occasions.
In short, stable value and money market funds have more differences than similarities. These differences do not necessarily make one better than the other but it is fair to say that the average stable value fund should credit a higher rate of interest than the average money market fund over the long haul.
That said: neither of these investment types is designed to significantly outperform inflation. To put it another way, they are both parking spots for your money that offer less risk and significantly less return than the other options within your menu.
As always, please make sure that you read up on all of the specifics of any investment before you buy it.
* Originally published September, 2008