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First, these so -called "mutual funds" are not mutual funds at all. One may also wonder if they are stable, as well.
Throughout the bizarre financial conditions that we’ve experience over the last several months, investors have found out that it is better to investigate everything, even investment vehicles that promote themselves as “stable”. Perhaps even more so.
Think about this. You are acquainted with the risks of the stocks. You understand that when you invest in stocks, you can lose money and sometimes lots of it. These are things that you now recognize because you’ve learned from experience, unfortunately.
However, we need to learn to condition ourselves to ask questions of investments that promote themselves as stable, secure or safe. AIG, Lehman, GM and Chrysler and the entire real estate market have surely taught us that point, if nothing else.
We certainly don’t want to get blind-sided from an investment type that we trust……again.
What is a Stable Value Fund?
Like a mutual fund, a stable value fund is a basket that holds securities. These securities are generally short-term, high-quality bonds. (Remember bonds are loans that the bond-holder makes to an entity such as a government, municipality or corporation.)
Because these bonds are generally more short-term in nature, they are considered safer. This is true because when you make a loan to someone or something, the risk of them defaulting becomes greater and greater the longer the time allowed for them to pay it back. More “bad things” can happen in a longer period of time than in a shorter one.
What makes a stable value fund unlike short-term bond mutual fund is that, generally, a stable value fund manager’s primary objective is to not lose money.
How does a stable value fund accomplish this? First, stable value fund managers buy bonds. The difficulty with bonds, however, is that they are valued at market value and the prices fluctuate, sometimes negatively. But, as stated earlier, stable value funds’ primary objective is to provide investors with positive returns.
So, to accomplish stability, stable value funds make contracts with insurance companies and insurance companies guarantee the value of the fund.
If a market value of the fund goes under $1, the insurance company will make up the difference. If the market value goes over $1, the insurance company takes a little off the top. This arrangement with an insurance company provides consistent, smooth returns.
The key then to a healthy stable value fund is in the market value / book value ratio. Ideally, the closer market value is to book value, the better. It stands to reason then that the lower the market value, the more dependent you are on the financial strength of the insurance company for stabilizing your fund.
Here’s the takeaway for you, the informed 401k investor. Find out the market value of your stable value fund. If the market value of your fund is below 90%, find out if there are alternatives.
Remember this, though. Many plans will require you to either wait for a certain number of days before you can take money out of a stable value fund. Also, there are some plans that will keep you from moving from stable value to money market or a TIPS fund for example.
The additional research on your "stable value mutual fund" may take a little effort, but it may pay off some day.
401kFundAdvice is a small, yet powerful 401k investment advisory firm.